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Regulation D

Regulation D

Regulation D

Regulation D allows the raising of funds and capital through private offerings of debt and/or equity securities without registering the securities with the Securities Exchange Commission (SEC). Regulation D is not to be confused with the Federal Reserve Board Regulation D, a regulation that limits withdrawals from savings accounts. Many companies prefer raising capital under Regulation D versus going through a public offering's tedious requirements. Regulation D offerings give companies plenty of time to sell securities that cannot be issued under certain circumstances. Companies raising funds through a Regulation D investment typically have less burdensome requirements compared to those of traditional public offerings. Several clauses within the regulation emphasize how issuers can solicit prospective investors from their network.

What is Regulation D?

Regulation D set SEC regulatory measures for implementing private placement exemptions. Raising capital through Regulation D is beneficial, as it streamlines the acquisition of funds for private companies. Without a public offering and at a significantly lower cost, small entrepreneurs can expand their capital through the sale of equity or debt securities. While extremely advantageous to up and coming businesses, regulatory requirements apply under Regulation D. Regulation D imposes numerous rules highlighting qualifications for issuing securities' registration requirements. This regulation divides into three main exemptions: Rules 501, 502, and 503. Rule 501 defines all terms utilized throughout Regulation D. Rule 502 subsequently refers to important conditions required to meet certain exemptions under Regulation D. Conditions stated in Rule 502:

  • Issuers must provide information and disclosures
  • General Solicitation is prohibited
  • When securities sold are placed on the market again, one must observe certain restrictions

Lastly, Rule 503 requires all issuers to fulfill a Form D with the SEC. Businesses must file this form before making an offering under Regulation D.

Legal Requirements for Regulation D

Entrepreneurs can raise their capital with only one or two investors under Regulation D.

Businesses, however, still must adhere to state and regulatory measures. Issuers must submit both the proper framework and disclosure documentation.

Form D

Issuers must file Form D with the SEC. One can access and file this form online after an initial sale of securities. Form D requires far less information to complete than the lengthy forms involved in public offerings. One must simply record names and addresses of a company's executives and directors, in addition to disclosing a few details regarding an offering.

Disclosure Documentation

Under Registration D, security issuers must submit disclosure documentation of "bad actor" events before making a sale. These events refer to issuers’ history with criminal justice. If a company has not received a written disclosure, it is allowed to claim that it was unaware of its employees' checkered past.

Regulation D does not exempt issuers against rules that can make them non-compliant to applicable state laws. Due to federal registry rules, all transactions that commence under Regulation D are not exempt from anti-fraud, civil liability, or other provisions of federal securities laws. Similarly, state regulations where Regulation D is adopted are still in play. For instance, some states require issuers to disclose notices of sale at a given time. A state can then summon any individuals involved in a transaction related to securities sales when necessary.

Regulation D Exemption Requirements

Issuers must meet an exemption from registration according to Section 4(a)(2). According to SEC.gov, exemption according to Section 4(a)(2), the “private placement” exemption, requires securities purchasers to:

  • Have enough knowledge or experience in finance and business to be considered “sophisticated investors,” which involves ability to evaluate risks and merits of an investment and bearing economic risk
  • Agree to not resell or distribute securities to the public
  • Have access to information typically provided in a prospectus from a registered securities offering

Some requirements associated with raising funds through a Regulation D investment are:

  • Because Regulation D investments are private offerings, public advertising for offerings and general investor solicitations are generally disallowed. Exceptions have been made recently with the introduction of Rule 506(c) (discussed below)
  • A company or issuer must have a proper framework and provide disclosure documentation – Form D must be filed electronically within 15 days after initial sale of securities
  • Issuers must disclose any prior “bad actor” events, such as securities fraud or criminal conviction

Three exemptions from Securities Act registration exist for offerings and securities under Regulation D:

Rule 504

Rule 504 provides an exemption for offerings and securities of about $5 million over a 12-month period. Companies can leverage Rule 504 as long as issuers adhere to reporting requirements established by the Exchange Act of 1934. General offerings and solicitations are also allowed under this rule. This exemption, however, is solely for accredited investors.

Rule 505

The Rule 505 exemption is currently out of date. Since courts repealed this rule in 2016, its provisions integrate into the Rule 504 exemption. Although Rule 505 originally exempts offerings and security sales reaching $5 million over 12 months, this rule allows the sale of securities to an unlimited number of "accredited investors.” Additionally, selling securities is limited to a maximum of 35 "unaccredited investors.” Both the capital limit worth $5 million and the submission of "bad actor" events are in Rule 504.

Rule 506

A Rule 506 exemption requires certain standards, such as:

  • A company must be capable of raising an unlimited amount of capital
  • Those who sell securities must be readily available to respond to inquiries from prospective buyers
  • Adherence to financial statement requirements per Rule 505
  • A buyer cannot trade restricted securities in a secondary market after their first sale

Unlike Rule 505, transactions under Rule 506 require that non-accredited investors have substantial financial literacy and experience in business matters. This unique opportunity gives them an advantage in analyzing the risks of making investments and evaluating merits.

Regulation D Offerings

Regulation D exemptions allow two main types of offerings which each follow specific rules:

Regulation D 506(b),

  • A company cannot use general solicitation or advertising to market its securities
  • A company can sell its securities to an unlimited number of "accredited investors" and as many as 35 other purchasers. All non-accredited investors, either alone or with a purchaser representative, must be sophisticated, meaning they must have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of a prospective investment
  • A company must decide what information to give to accredited investors, so long as said information does not violate any antifraud prohibitions of federal securities laws. Any information a company provides to investors must be free from false or misleading statements. A company must give non-accredited investors disclosure documents that are generally the same as those used in Regulation A or registered offerings, including financial statements, which in some cases may need an accountant’s certification. If a company provides information to accredited investors, it must make this information available to non-accredited investors as well
  • A company must be available to answer questions by prospective purchasers

Rule 506(c) allows a company to broadly solicit and generally advertise an offering while still complying with the exemption’s requirements if:

  • All investors in an offering are accredited
  • A company takes reasonable steps to verify that any investors are accredited, which could include reviewing documentation such as W-2s, tax returns, bank and brokerage statements, and credit reports

By following Regulation D’s guidelines, a company issuing a security under does not have to register with the SEC but needs to instead file Form D.