General Overview of Securities Act Exemptions for the Novice

By Amber Condron and Richard Weintraub 

Clients that are starting or growing their business often come to their attorneys with a conundrum: they need money and have no idea how to go about raising it compliantly.  Raising money compliantly can be tricky as it involves compliance with state securities laws, known as “Blue Sky Laws,” and federal law. There are five major federal securities laws contained in Title 15 of the U.S. Code that need to be reviewed when conducting an interstate offering:

1. Securities Act of 1933 (“Securities Act”)1 – regulating distribution of new securities

2. Securities Exchange Act of 19342 – regulating trading securities, brokers, and exchanges

3. Trust Indenture Act of 19393 – regulating debt securities

4. Investment Company Act of 19404 – regulating mutual funds

5. Investment Advisers Act of 19405 – regulating investment advisers

In 2010 the Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into federal law. In 2012 the Jumpstart Our Business Startups Act or “JOBS Act” was enacted and substantially changed a number of laws and regulations making it easier for companies to both go public and to raise capital privately and stay private longer. This Article will focus on the Securities Act, as modified by the JOBS Act.

The Securities Act requires that any offer or sale of securities using interstate commerce be registered with the SEC, unless an exemption from registration exists under the law. Issuers must fully disclose all material information that a reasonable shareholder would require in order to make up his or her mind about the potential investment. A company that is required to register under the Securities Act must create a registration statement, which includes a prospectus, with copious information about the security, the company, the business, including audited financial statements. The company, the underwriter and other individuals signing the registration statement are strictly liable for any inaccurate statements in the document.6

Exemptions from the registration requirements include:

1. Non-public offering (“private placement”) exemption – Section 4(a)(2) of the Securities Act, exempts from registration “transactions by an issuer not involving any public offering.”  In general, public advertising of the offering, and general solicitation of investors, is not allowed. The precise limits of the non-public offering exemption are not defined by rule.7

2. Regulation D (17 CFR § 230.501 et seq.) – contains Rules 504 and 506, which establish exemptions from the Securities Act registration. Issuers must file a notice on Form D with the SEC within 15 days after the first sale of securities in the offering.

a. Rule 504, sometimes referred to as the “seed capital” exemption, provides an exemption for the offer and sale of up to $5,000,000 of securities in a 12-month period by a company that is not a blank check company and does not have to file reports under the Securities Exchange Act of 1934. In general, the issuer may not use general solicitation or advertising to market the securities,8 and purchasers generally receive “restricted securities.”9

b. Rule 506, is considered a “safe harbor” for the private placement exemption. Under Rule 506 there are actually two ways of conducting an exempt offering for “restricted securities,” Rule 506(b) and Rule 506(c). Issuers can raise an unlimited amount of money.10

i. Under Rule 506(b) the issuer must:

• not use general solicitation or advertising to market the securities;
• not sell securities to more than 35 non-Accredited Investors who either alone or with a purchaser representative meet the legal standard of having sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment;
• give non-Accredited Investors specified disclosure documents that generally contain the same information as provided in registered offerings;11
• be available to answer questions from prospective purchasers who are non-Accredited Investors; and
• provide the same financial statement information.

ii. Rule 506(c) was implemented pursuant to Section 201(a) of the JOBS Act, and allows issuers to offer securities through means of general solicitation, provided that:

• all purchasers in the offering are Accredited Investors,
• the issuer takes reasonable steps to verify their Accredited Investor status, and
• certain other conditions in Regulation D are satisfied.

3. Accredited Investor exemption – Section 4(a)(5) of the Securities Act exempts from registration offers and sales of securities to Accredited Investors when the total offering price is less than $5 million. This exemption does not permit any form of general solicitation or advertising.12

4. Intrastate offering exemption – Section 3(a)(11) of the Securities Act facilitates the financing of local business operations and does not limit the size of the offering or the number of purchasers (although, the Issuer may be limited by Blue Sky Laws). To qualify for the intrastate offering exemption, the issuer’s principal place of business must be in the state where it is offering the securities; carry out a significant amount of its business in that state; and make offers and sales only to residents of that state. The issuer may follow Rule 147 or 147A, non-exclusive “safe harbors,” to ensure that the issuer meets the requirements for the intrastate offering exemption.13

5. Coordinated limited offering exemption under California law – 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 Section 25102(n) of the California Corporations Code. This California law exempts offerings made by California companies to “qualified purchasers” whose characteristics are similar to, but not the same as, Accredited Investors under Regulation D. The California provisions allow limited general solicitation before sales. Securities issued under this exemption are “restricted securities.”14

6. Exemption for sales of securities through employee benefit plans – Rule 701 provides an exemption from registration for securities issued by non-reporting companies pursuant to compensatory arrangements.15

All securities transactions, even exempt transactions, are subject to the antifraud provisions of the federal securities laws. Regardless of whether securities must be registered, the Securities Act makes it illegal to commit fraud in conjunction with the offer or sale of securities. A defrauded investor can sue for recovery under the Securities Act.

Amber Condron is Senior Attorney at Weintraub Law Group, P.C. and Richard Weintraub is the Founder of Weintraub Law Group PC.

This article is for information purposes only and does not contain or convey legal advice.  The information herein should not be relied upon in regard to any particular facts or circumstances without first consulting an attorney. Any views expressed are those of the author only and not of the SDCBA or its Business & Corporate Law Section.