Regulation D Requirements
Regulation D contains several regulatory safe harbor exemptions from the Securities Act registration requirements, each set out under Rules 504, 506(b), and 506(c), and each with its own offeree qualifications and limitations. Regulation D is non-exclusive, so even if a placement fails to comply with the technical requirements of Regulation D, another exemption under the Securities Act may still be available (Rule 500(c)).
Like securities sold under Section 4(a)(2), securities sold under Regulation D (except for certain securities sold under Rule 504 of Regulation D) are considered restricted securities for purposes of Rule 144 and cannot be freely resold to the public without registration or exemption from registration.
The safe harbor exemptions under Regulation D have the following limitations:
Rule 504 (under Section 3(b)(1))
Maximum size of offering $10 million (in aggregate with all securities sold under Section 3(b)(1) or in violation of Section 5(a) of the Securities Act) per year.
Issuers permitted to rely on this exemption Non-reporting companies (including foreign private issuers that provide information under Rule 12g3-2(b) of the Securities Exchange Act of 1934, as amended (Exchange Act)); companies that are neither investment companies (as defined in the Investment Company Act of 1940, as amended (ICA)), nor blank check companies.
“Bad actor” disqualification Bad actor disqualification by reference to Rule 506 bad actor disqualification.
Types of investors that can buy the securities Any investor. No limits on number or sophistication of investors.
Standard of verification required for accredited investors Not applicable.
Issuer required to furnish certain information? No.
Prohibition on general solicitation or advertisement? Yes, subject to the exceptions provided by Rule 504(b)(1). (17 C.F.R. § 230.504)
Limitations on resale of securities? Yes, subject to the exceptions provided by Rule 504(b)(1).
Subject to integration? Yes.
Form D filing? Yes.
State law (blue sky) registration and qualification requirements pre-empted? No.
Rule 506(b) (supplement to Section 4(a)(2))
Maximum size of offering No limit on size of offering.
Issuers permitted to rely on this exemption Any issuer. It can be used by both reporting companies and non-reporting companies.
“Bad actor” disqualification Bad actor disqualification for companies in which any officers, directors, general partners, 20% owners, or underwriters have been convicted or subject to SEC or other orders within the past five to ten years.
Types of investors that can buy the securities An unlimited number of accredited investors and up to 35 non-accredited investors (who alone or together with their purchaser representatives must be sophisticated investors).
Standard of verification required for accredited investors Issuer must have reasonable belief that investor is an accredited investor.
Issuer required to furnish certain information? Yes, to non-accredited investors.
Prohibition on general solicitation or advertisement? Yes.
Limitations on resale of securities? Yes.
Subject to integration? Form D filing? Yes.
State law (blue sky) registration and qualification requirements pre-empted? Yes.
Rule 506(c) (supplement to Section 4(a)(2))
Maximum size of offering No limit on size of offering.
Issuers permitted to rely on this exemption Any issuer. It can be used by both reporting companies and non-reporting companies.
“Bad actor” disqualification Bad actor disqualification for companies in which any officers, directors, general partners, 20% owners, or underwriters have been convicted or subject to SEC or other orders within the past five to ten years.
Types of investors that can buy the securities An unlimited number of accredited investors.
Standard of verification required for accredited investors Issuer must have reasonable belief that investor is an accredited investor. Issuer must take reasonable steps to verify that all investors are accredited investors.
Issuer required to furnish certain information? No.
Prohibition on general solicitation or advertisement? No.
Limitations on resale of securities? Yes.
Subject to integration? Yes.
Form D filing? Yes.
State law (blue sky) registration and qualification requirements pre-empted? Yes.
Accredited Investors
The accredited investor classification is important for three reasons:
• Rule 506(b) limits the number and type of buyers. Rule 501(e) of Regulation D explains how to calculate the number of buyers under Rule 506(b) but exempts any accredited investor from this calculation. Therefore, securities can be sold to an unlimited number of accredited investors under Rule 506(b).
• Rule 502(b) requires certain information to be furnished to non-accredited investors for offers made under Rule 506(b).
• Rule 506(c) allows the issuer to use general solicitation and general advertising in connection with a Rule 506(c) offering if all the buyers of the securities are accredited investors, and the issuer takes reasonable steps to verify that the buyers are accredited investors.
Rule 501(a) of Regulation D provides the following categories of accredited investors, including investors that the issuer reasonably believes qualify as:
• Institutional investors, including:
• US banks (Section 3(a)(2), Securities Act);
• US branches or agencies of foreign banks (from SEC guidance);
• savings and loan associations (Section 3(a)(5)(A), Securities Act);
• registered broker-dealers;
• registered investment advisers;
• investment advisers exempt from registration under Section 203(l) or (m) of the Investment Advisers Act of 1940 (Advisers Act);
• registered investment companies;
• business development companies;
• insurance companies;
• small business investment companies; and
• rural business investment companies.
• Private business development companies.
• Corporations, partnerships, limited liability companies, and tax-exempt organizations with total assets of more than $5 million.
• The issuer’s directors, executive officers, and general partners.
• Individuals with a net worth, or joint net worth with their spouse, of more than $1 million at the time of purchase. Under Rule 501(a), in calculating a person’s net worth (the amount of assets in excess of liabilities):
• The value of the person’s primary residence is not included as an asset.
• The amount of debt secured by the primary residence, up to its estimated fair market value, is not included as a liability, unless some or all of the secured debt is incurred within 60 days before the sale of securities to the person, and the debt was not incurred for the purpose of buying the residence. In that situation, the amount of secured debt outstanding at the time of the sale of the securities that exceeds the amount outstanding 60 days before the sale must be included as a liability. This provision is meant to prevent investors from borrowing against their homes in order to invest in unregistered offerings.
• Any debt secured by the primary residence in excess of the estimated fair market value of the home at the time of the sale of securities is included as a liability.
• In addition to the net worth calculations described above, when calculating joint net worth, the primary residence does not need to be held jointly, and the purchase of securities does not need to be made jointly for the investor to qualify under the joint net worth test.
• The calculation of an individual’s net worth may include in the individual’s total assets any assets in accounts or properties held jointly with another person who is not the individual’s spouse, to the extent of the individual’s ownership percentage.
• Individuals with an annual income of more than $200,000, or joint annual income with their spouse of more than $300,000, for each of the last two years. If the income is not reported in US dollars, annual income may be calculated using either the exchange rate in effect on the last day of the year for which income is being measured or the average exchange rate for that year.
• Trusts with assets of more than $5 million.
• Entities whose equity owners are all accredited investors.
• Any other type of entity that owns investments in excess of $5 million.
• Individuals who hold certain professional certifications, designations, or other credentials.
• Individuals who are “knowledgeable employees” of private funds and are investing in the private fund.
• Family offices meeting certain conditions.
• Family clients meeting certain conditions.
Rule 506(b) also limits sales to 35 non-accredited investors. However, because Rule 506(b) is a safe harbor established under Section 4(a)(2), non-accredited investors in Rule 506(b) offerings must still satisfy the investor suitability criteria required for a private placement. A non-accredited investor in a Rule 506(b) offering must generally be a sophisticated investor who, either individually or with their purchaser representative, can evaluate the economic risks and merits of the proposed offering (Rule 506(b)(ii)). A purchaser representative acts as an investment adviser, but is not an affiliate, director, officer, or other employee of the issuer or a shareholder owning 10% or more of the issuer. Under Rule 501(i), these “insiders” are barred from acting as a purchaser representative unless they share a certain relationship, such as a familial relationship, with the non-accredited investor.
Questionnaires
The issuer typically uses investor questionnaires to help collect and verify information about potential investors’ suitability to participate in a Section 4(a)(2) or Rule 506(b) offering. An issuer conducting a Rule 506(c) offering cannot rely solely on an investor questionnaire as it must take additional steps to verify the accredited investor status of its potential investors. A potential non-accredited investor in a Rule 506(b) offering can qualify to participate in the offering if it is a sufficiently sophisticated investor or by using a purchaser representative. In such cases, a questionnaire is also sent to the purchaser representative to verify that it is qualified to participate.
The issuer has the burden of determining the status of potential investors. If the issuer sells unregistered securities to an unqualified investor, the issuer may not be able to rely on the private placement exemption. Selling without a registration statement or valid registration exemption gives each purchaser (not just the unqualified purchaser) the right to rescind or cancel its purchase and recover the purchase price (plus interest) from the issuer for one year after the sale. Under Section 12(a)(1) of the Securities Act, a purchaser no longer holding the securities can recover damages from the issuer regardless of whether or not its losses arise from the issuer’s failure to register those securities. To avoid this strict liability, issuers rely on investor questionnaires to protect the availability of their registration exemptions under Section 4(a)(2) or Rule 506(b). If a purchaser representative is used in a Rule 506(b) offering, the purchaser representative questionnaire and the investor questionnaire together help the issuer establish the status of its investor base and avoid the Section 12(a)(1) strict liability.