The Securities Act of 1933 (the “Securities Act”) provides for a private offering or private placement exemption from federal securities registration which is increasingly being used by both public companies and private companies seeking to go public to raise capital during market downturns and in times of market uncertainty.
While the term “private offering” leaves much to the imagination, the Securities Act provides substantial guidance about the circumstances in which an offering will be deemed a private placement. Most private placements are made in reliance upon Rule 506 of Regulation D.
Whether an offering is deemed a private offering is determined by various interpretations of relevant SEC releases and case law. An issuer seeking to raise capital in a private placement should consider a 4 factor test.
When is an Offering a Private Placement?
The SEC has identified four factors to be used in determining whether an intended private placement offering is a public offering:
♦ The number of offerees (not only those who invest) and their relationship to each other and the company conducting the offering;
♦ The number of securities offered in the private placement;
♦ The size of the offering; and
♦ The manner in which the offering is conducted.
Authority for Private Placement Offerings Under Section 4(2) & Rule 506 of Regulation D
The private placement exemptions under the Securities Act are:
♦ Section 4(a)(2) of the Securities Act, which provides a statutory exemption for “transactions by an issuer not involving any public offering”; and
♦ Rule 506 of SEC Regulation D, which provides a regulatory safe harbor for an issuer engaged in a non-public offering.
Qualification of Investors in Section 4(2) & Rule 506 Private Placement Offerings
Generally, Section 4(a)(2) & Rule 506 offerings are limited to persons capable of fending for themselves. Offerings made under Rule 506 may be made to up to 35 non-accredited and an unlimited number of accredited purchasers.
The definition of accredited investor is found in Rule 501(a). An accredited investor is any person whom the issuer reasonably believes falls within any of the following categories at the time of the sale of securities to that person:
♦ 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 decision, 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 who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase not including the value of the person’s primary residence, or the mortgage or debt secured by the primary residence if the amount of that debt is less than the fair market value of that residence;
♦ a natural person with income exceeding $200,000 in each of the two most recent years of 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 in excess of $5 million, not formed to acquire the securities offered, whose purchases are made by a financially sophisticated person.
The issuer conducting a private placement offering in reliance upon either 4(a)(2) or Rule 506 must establish that:
♦ the intended private placement offering meets the required purchaser qualification requirements;
♦ the issuer conducting the private placement complies with the informational requirements of the securities laws;
♦ the private placement offering is not integrated with another exempt or registered securities offering;
♦ the securities offering does not involve any general solicitation or advertisement; and
♦ the securities offering includes appropriate resale restrictions which are communicated to potential investors.
The securities exemptions provided by Section 4(a)(2) and Rule 506 are only available for private placement offerings made by an issuer. Investors in these offerings must either register their shares or locate another exemption from SEC registration. The securities issued and sold to investors in private placement offerings are restricted securities.
Section 4(a)(2) and Rule 506 contain informational requirements for private placement offerings. If a disclosure obligation exists, the information must be provided prior to the time of sale.
Disclosure Requirements in Section 4(2) & Rule 506 Private Placement Offerings
Each offeree must possess or have access to the type of information that would be included in a registration statement and which would enable the offeree to make an informed investment decision. This information generally addresses the issuer’s business & related risks, securities, history, financial condition, results of operations, property, and management.
Disclosures in Section 4(2) & Rule 506 Private Placement Offerings
There are no informational requirements for accredited investors in private placements made under Rule 506; however, SEC Rule 10b-5, under the Securities Exchange Act of 1934 (the “Exchange Act”), creates liability for material misstatements or omissions
Each of the 35 non-accredited purchasers must receive certain information, which varies depending on the nature of the issuer and the size of the offering.
Non-reporting issuers conducting private placement offerings must provide investors with certain non-financial information and with specific types of financial statement information depending upon the size of the offering.
Reporting companies must furnish the same disclosures regardless of the size of the private placement offering. This information may either be:
♦ An issuer’s most recent annual report to shareholders. It must meet the requirements of Exchange Act Rule 14a-3 (which specifies the information required to be delivered in connection with proxy solicitations) or Rule 14c-3 (annual report information requirements delivered in non-proxy solicitations prior to an annual meeting or other shareholder meeting), the definitive proxy statement filed in connection with that annual report, and, if requested in writing, the issuer’s most recent Form 10-K; or
♦ The information contained in the issuer’s most recent annual report on Form 10-K or a Form 10 under the Exchange Act or a Form S-1 under the Securities Act.
Issuers must update and supplement any disclosures provided with additional information and must provide disclosures regarding material changes concerning the issuer that are not covered in documents furnished to investors. An issuer seeking to conduct a private placement could lose its exemption from registration if it does not comply with the requirements of the exemption. As such, issuers should consult a competent securities attorney to guide them through the rules and regulations applicable to private placements.