Even if a company makes a private sale where there are no specific disclosure delivery requirements, it should take care to provide sufficient information to investors to avoid violating the antifraud provisions of the securities laws. This means that any information it provides to investors must be free from false or misleading statements. Similarly, the company should not exclude any information if the omission makes what it does provide investors false or misleading.
Rule 505
Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, you may sell to an unlimited number of "accredited investors" and up to 35 other persons who do not need to satisfy the sophistication or wealth standards associated with other exemptions. Purchasers must buy for investment only, and not for resale. The issued securities are "restricted." Consequently, a company must inform investors that they may not sell for at least a year without registering the transaction. The company may not use general solicitation or advertising to sell the securities.
An "accredited investor" is:
- a bank, insurance company, registered investment company, business development company, or small business investment company;
- an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
- a charitable organization, corporation, or partnership with assets exceeding $5 million;
- a director, executive officer, or general partner of the company selling the securities;
- a business in which all the equity owners are accredited investors;
- a natural person with a net worth of at least $1 million;
- a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
- a trust with assets of at least $5 million, not formed to acquire the securities offered, and whose purchases are directed by a sophisticated person.
It is up to the company to decide what information to give accredited investors, so long as it does not violate the antifraud prohibitions. But the company must give nonaccredited investors disclosure documents that generally are the same as those used in registered offerings. If it provides information to accredited investors, it must make this information available to the nonaccredited investors as well. The company must also be available to answer questions by prospective purchasers.
This type of filing mandates the following financial statement requirements:
- Financial statements need to be certified by an independent public accountant;
- If a company other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the company's balance sheet, to be dated within 120 days of the start of the offering, must be audited; and
- Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish audited financial statements prepared under the federal income tax laws.
Rule 506
Rule 506 is a "safe harbor" for the private offering exemption. If a company satisfies the following standards, it can be assured that it is within the Section 4(2) exemption:
- The company can raise an unlimited amount of capital;
- The company cannot use general solicitation or advertising to market the securities;
- The company can sell securities to an unlimited number of accredited investors (see Rule 505) and up to 35 other purchasers. Unlike Rule 505, all nonaccredited investors, either alone or with a purchaser representative, must be sophisticated - that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment;
- The company must decide what information to give accredited investors, so long as it does not violate the antifraud prohibitions. But it must give nonaccredited investors disclosure documents that generally are the same as those used in registered offerings. If it provides information to accredited investors, it must make this information available to the nonaccredited investors as well;
- The company must be available to answer questions by prospective purchasers;
- Financial statement requirements are the same as for Rule 505; and
- Purchasers receive "restricted" securities. Consequently, purchasers may not freely trade the securities in the secondary market after the offering.
Accredited Investor Exemption: Section 4(6)
Section 4(6) of the Securities Exchange Act exempts from registration offers and sales of securities to accredited investors when the total offering price is less than $5 million.
The definition of accredited investors is the same as that used in Regulation D. Like the exemptions in Rule 505 and 506, this exemption does not permit any form of advertising or public solicitation. There are no document delivery requirements. Of course, all transactions are subject to the antifraud provisions of the securities laws.
California Limited Offering Exemption: Rule 1001
SEC Rule 1001 provides an exemption from the registration requirements of the Securities Act for offers and sales of securities, in amounts of up to $5 million, that satisfy the conditions of § 25102(n) of the California Corporations Code. This California law exempts from California state law registration offerings made by California companies to "qualified purchasers" whose characteristics are similar to, but not the same as, accredited investors under Regulation D. This exemption allows some methods of general solicitation prior to sales.
Exemption for Sales of Securities through Employee Benefit Plans: Rule 701
The SEC's Rule 701 exempts sales of securities if made to compensate employees. This exemption is available only to companies that are not subject to Securities Exchange Act reporting requirements. A company can sell at least $1,000,000 of securities under this exemption, no matter how small its size. It can sell even more if it satisfies certain formulas based on its assets or on the number of its outstanding securities. If the company sells more than $5 million in securities in a 12-month period, it needs to provide limited disclosure documents to its employees. Employees receive "restricted securities" in these transactions and may not freely offer or sell them to the public.
Source: Securities and Exchange Commission
Copyright 1999 Findlaw Inc.
