Exemptions for Selling Unregistered Stock
To sell a private security offering (or an unregistered stock) can be a time consuming, expensive, and risky move. Registering the security (which is typically required by law, under the Security Act of 1933) can take a long time, especially when one factors in the use of all the proper channels. Failure to comply with all of these specific policies can heap hefty fines on the unsuspecting business owner, as well as draw the scrutiny of the respective governing agencies. In the meantime, investors might change their minds. A disciplinary action from the authorities can also prevent a business owner from qualifying for exemption status in the future.
There is a way to sell private security offerings without the headache and hassle. Using the proper routes, a business owner can sell these securities under an exempt status. The Security and Exchange Commission passed the Security Act of 1933, which allowed for certain exemptions under regulations 504, 505, and 506. These are referred to under Regulation D (or Reg D).
These exemptions are offered to those selling private securities to a specific set of buyers. The specifics depend on which exemption one qualifies for, and can vary even within the same rule. These variations include the type of business, what the sales money will be used for, and how much money will be exchanged.
Further restrictions include those made upon the buyer. Buyers are not to have been notified of the security sales through a public means, such as a public seminar or conference. Public advertising regarding the sale is restricted. Likewise, the sold securities are held to a high standard, and require that the buyer register them before selling them, or seek out exempt status personally.
This is the most basic of the three exemption laws. Under rule 504, private security owners can sell up to one million dollars in private securities, over a term of one year, to an unlimited number of buyers. This is an important point, as there are no regulations on the type of buyer (in the other two rules, the type of buyer is restricted). Another plus is that no information regarding the securities has to be disclosed to the buyers (except that which is required by law for every security sale).
The downfall of rule 504 is the dollar limit imposed, which is often a fraction of the funds a business actually requires.
The second of the exemption rules offered under regulation D is rule 505. This rule is more ideal for those companies that wish to offer and sell a larger number of securities, dollar wise. Under rule 505, up to five million dollars in private securities are permitted to be offered and sold, as long as they are sold to accredited buyers, or up to thirty-five other buyers.
An accredited buyer is a person whose assets or net worth is in excess of one million dollars, and whose income for at least the last two years straight reaches a minimum of two hundred thousand dollars per year (or three hundred thousand combined with spouse). Chief officers of the offering company are also deemed accredited buyers, and are therefore eligible to make a purchase.
As long as the security offerings are sold to these accredited buyers, the same loose discloser rules apply. The seller is only required to disclose the basic information that is required of all security offering sales.
The downside of rule 505 is that if non-accredited buyers purchase any securities, the company is required to disclose a myriad of different materials to buyers. These include financial statements, audited and verified balance sheet dated within the last one hundred and twenty days, and any information needed to verify the facts being presented. The companies must also offer buyers the opportunity to ask questions and receive answers before making a final purchase.
Furthermore, if even one non-accredited buyer makes a purchase, this discloser information must be presented to all of the other buyers, accredited or not. Because of these regulations, rule 505 is not often used to sell to non-accredited buyers.
The last of the three regulation D rules, and easily the most popular exemption, is rule 506. This rule offers many benefits to companies that wish to sell private security offerings. For starters, a company can sell an unlimited number of securities, and therefore raise an unlimited amount of money. A second benefit is that these securities can be offered to an unlimited number of sophisticated buyers, with no more than thirty-five non-accredited buyers.
A sophisticated buyer is one who is guaranteed to have sufficient knowledge in selling, trading, and purchasing securities and stocks, or who has sufficient knowledge to know what he or she is doing in completing the transaction. This can also be any person who has proof that he or she sought professional advice on the matter. An accredited buyer is automatically considered a sophisticated buyer.
The discloser policies for rule 506 are the same as in rule 505.
And added bonus to rule 506 is that Congress has pre-empted certain regulations regarding state laws. These regulations allow buying between states with little or no interference from state regulators. Often the only requirements are a minimal fee and an advisory filing. This makes interstate trading much easier when using rule 506.
Regulations by State
Each state has their own set of regulations where the sales of private security offerings are concerned. When selling within the same state these rules apply. Then only time these regulations are pre-empted is when rule 506 is applied. In this instance, trading between states is made much simpler.
State regulations were put into place to further protect unsuspecting buyers. They are called Blue Sky Regulations, to protect from sales that are worth about as much as a patch of “blue sky”.
Filing requirements for those filing under exemptions 504, 505, or 506 include the completion of a File D form. Five copies of this form are to be completed and returned under Regulation D standards. The form is technically not required, and is used to help the Securities and Exchange Commission collect data and statistics on the effectiveness of private securities offerings on small business profits.
While it is not a requirement, the lack of its use is frowned upon. It can hinder the company from qualifying for Regulation D exemptions in the future.
An exempted private securities offering or unregistered stock can be ideal for a business owner who is looking to raise funds for a future business venture. The benefits far exceed the time and effort put forth.
However, it is recommended that any business owner seek professional legal counsel before making this decision. This will ensure that the business qualifies under all federal and state exemption laws, and that all policies are followed to the letter of the law.