RULE 504 AMENDMENTS EFFECTIVE APRIL 7, 1999
The Securities and Exchange Commission (the "SEC") recently adopted amendments to Rule 504 of Regulation D ("Rule 504"). Rule 504 provides an exemption from registration under the Securities Act of 1933 (the "Act") for offerings of non-reporting issuers to raise "seed capital" in an aggregate amount of no more than $1 million in a 12-month period.
Rule 504 Amendments
The amendments to Rule 504 generally provide that securities issued pursuant to Rule 504 will be restricted securities for resale purposes, and general advertising and solicitation with respect to such securities will be prohibited, unless one of the following conditions is met:
- the securities are sold only in states requiring registration of the securities, and such states require a public filing and distribution of a disclosure document to potential investors prior to any sale of the securities;
- the securities are sold in states having no requirement for registration of the securities, as long as the securities have been registered in at least one state requiring such registration, and as long as a disclosure document is delivered to all potential investors prior to any sale of the securities (including those potential investors located in states not requiring such registration); or
- the securities are issued under a state law exemption permitting general solicitation and advertising, but only if the securities are sold to "accredited investors" (as defined in Rule 501(a) of Regulation D).
Prior to Amendments
From July 1992 until April 7, 1999, a non-reporting issuer could offer and sell securities to an unlimited number of unaccredited investors in reliance upon Rule 504 in an amount not to exceed $1 million in any 12-month period. Issuers engaging in such transactions were not subject to the disclosure obligations applicable to issuers making offers or sales to unaccredited investors under Rules 505 or 506, and general solicitation and advertising with respect to such offerings were permitted. Finally, securities sold in such offerings were not subject to any restrictions on resale by the purchaser. The SEC had been of the view that such Rule 504 offerings were adequately monitored and regulated by state securities laws, most of which required registration. Also, Rule 504 offerings were subject to the antifraud provisions of the federal securities laws.
SEC Re-examines Position
In early 1998, the SEC determined that developments in the secondary market for securities sold under Rule 504 compelled a re-examination of the Rule 504 exemption. The SEC's concerns primarily surrounded "microcap" securities, which are characterized by low share prices, thin trading volume, limited public information and little or no analyst coverage. The SEC felt that offers and sales of freely resaleable "microcap" securities, through general solicitation and advertising and without adequate disclosure, presented significant investor protection concerns.
For most Rule 504 offerings, issuers may no longer engage in general solicitation and advertising, and any securities sold pursuant to Rule 504, as amended, will now be restricted securities for resale purposes. Some commenters to the SEC's proposed amendments to Rule 504 objected to this approach for all offerings under Rule 504 on grounds that such an approach would force Rule 504 issuers to offer a significant liquidity discount to investors to offset the fact that the securities sold under Rule 504 would be restricted securities. In response to these commenters, the SEC modified the proposed rule and provided that, as noted above, issuers still may engage in general solicitation and advertising, and may offer investors unrestricted securities, if such offerings
- are made only in states requiring registration of such securities, a public filing and the distribution of a disclosure document with respect to such securities;
- are made in states not requiring registration of such securities, as long as the securities are registered in at least one state and the disclosure document required by such state(s) is distributed to all investors (including those in any states which do not require such a procedure); or
- are made pursuant to a state law exemption allowing general solicitation and advertising as long as the offers and sales are made only to "accredited investors" (as defined in Rule 501(a) of Regulation D).
SEC Release 33-7644, in which the SEC adopts these amendments to Rule 504, indicates that a state law-mandated disclosure document distributed pursuant to these amendments must contain substantive disclosure, including the business and financial condition of the issuer (including financial statements), the risks of the offering, a description of the securities being offered, and the plan of distribution with respect to the securities.
Provisions of Rule 504 containing restrictions on the type of issuer and the aggregate offering price in a Rule 504 offering remain intact following the amendments. To take advantage of the Rule 504 exemption, the issuer must be "non-reporting," that is, not subject to the reporting requirements of Section 13 or Section 15(d) of the Securities Exchange Act of 1934. The issuer also may not be an investment company or a development stage company with no specific business plan or purpose. The aggregate offering price for securities sold pursuant to Rule 504 may not, in any 12-month period, exceed $1 million. This $1 million cap will be reduced by the aggregate offering price of any securities sold by the issuer in reliance on an exemption from registration under Section 3(b) of the Securities Act (such as Rules 505 and 506) within the twelve months prior to and during the offering of securities under Rule 504.
State Law Registration Requirements
Small Corporate Offering Registration ("SCOR") Program
Securities offerings which do not exceed $1 million in a 12- month period may be registered in many states under the SCOR registration program. SCOR is open to any issuer provided none of the following persons have been the subject of a range of specific law enforcement actions including any securities crime, fraud, state cease and desist order or injunction:
- the issuer,
- the issuer's officers,
- the issuer's directors,
- the issuer's 10% shareholders,
- promoters,
- selling agents,
- officers of selling agents,
- directors of selling agents and
- 10% shareholders of selling agents.
When a state is said to participate in the SCOR registration program, this means that the state has adopted laws, regulations and/or policy statements declaring that issuers filing a SCOR registration form (Form U-7) must comply with the instructions to the Form established by the North American Securities Administrators Association ("NASAA"). Other states have adopted the NASAA Instructions with modifications. Some states have not officially adopted laws, regulations or policies that recognize the NASAA instructions but nevertheless permit the filing of a Form U-7 subject to a state's own procedures.
Except for the following states, each state has either officially or unofficially adopted the SCOR registration program or recognizes the filing of a Form U-7 for Rule 504 offerings.
– Alabama
– California*
– District of Columbia**
– Florida
– Hawaii
– Nebraska
– New Hampshire
– New York***
*SCOR registration permitted only if the issuer is a California corporation or has a substantial presence in California
**No securities registration required
***No securities registration required, except for real estate securities
Model Accredited Investor Exemption
The Model Accredited Investor Exemption adopted by NASAA exempts from state securities registration the offer and sale of securities to accredited investors as defined in Rule 501 under Regulation D, provided the following conditions are met:
- the issuer reasonably believes that the accredited investors are purchasing for investment and not for resale.
- the issuer is not a development stage issuer that either has no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person.
- the issuer and affiliates have not been subject to various "bad boy" disqualifying provisions.
- the offering is not conducted using advertising, except for "general announcements". Unless otherwise permitted by the state securities administrator, a general announcement is restricted to:
- the name, address and telephone number of the issuer,
- name, price and aggregate amount of the offered securities and
- brief descriptions of the offered securities and the issuer's business.
- the offering is only to accredited investors,
- no money or other consideration will be solicited or accepted by means of the general announcement,
- the securities have not been registered with or approved by the SEC or any state agency and
- the securities are being offered and sold under a registration exemption.
- 15 days after the first sale in a state, a notice of the transaction must be filed (usually the Model Accredited Investor Exemption Notice of Transaction) with a Consent to Service of Process, a copy of the general announcement and a fee.
States that have adopted, either in whole or a substantial part of, the NASAA Model Accredited Investor Exemption are:
– Colorado
– Connecticut
– Delaware
– Indiana
– Kansas
– Kentucky
– Maine
– Nevada
– New Jersey
– Ohio
– Oklahoma
– Pennsylvania
– Rhode Island
– South Carolina
– South Dakota
– Texas
– Utah
– Washington
– Wyoming