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What is Reg. D?

Regulation D of the Securities Act of 1933—colloquially known as “Reg. D”—governs private placements of securities issued to so-called “accredited investors.” The importance of private placement securities cannot be overlooked, as according to Law360, “in 2018 companies raised more capital ($1.7 trillion) under Regulation D [Reg. D] private placement offerings than was raised in the public markets.”

These securities are unregistered and allow smaller companies to raise capital faster than they would be able to with a public offering. Who can invest in private placements? Typically,
“accredited investors” are “large banks, mutual funds, insurance companies, pension funds, family offices, and hedge funds,” according to FINRA. Rule 501 defines “accredited investors” as “persons with a net worth in excess of $1,000,000, or annual income in excess of $200,000 (or $300,000 jointly with a spouse). In reality, even accredited investors can be left vulnerable by capricious brokers who assume they have the “degree of financial sophistication” required by Rule 506. The vagueness of this requirement can mean accredited investors enter private placements without sufficient knowledge of what they are getting into.

To comply with Reg. D, firms must fill out SEC Form D—also known as the Notice of Sales of Securities—15 days after the first securities are sold. According to Investopedia, “Form D, however, contains far less information than the exhaustive documentation required for a public offering; it comprises the names and addresses of the company’s executives and directors, along with some details regarding the offering.”

Given the limited information often available to investors regarding alternative investments, brokers must investigate their suitability before recommending them to clients. According to FINRA Regulatory Notice 10-22, “A broker-dealer has a duty—enforceable under federal securities laws and FINRA rules—to conduct a reasonable investigation of securities that it recommends, including those sold in a Regulation D offering.” Furthermore, their investigation may include “the issuer and its management; the business prospects of the issuer; the assets held by or to be acquired by the issuer; the claims being made; and the intended use of proceeds of the offering.”

Reg. D comprises eight different rules, as outlined below:

Rule

Meaning

Rule 501 According to FINRA, “Rule 501 defines ‘accredited investor’ as any person who meets, or who the issuer reasonably believes meets, certain requirements, including natural persons with a net worth in excess of $1,000,000, or annual income in excess of $200,000 (or $300,000 jointly with a spouse).”
Rule 502 This outlines the general conditions to be met, including the fact that unregistered securities cannot be resold without being registered or exempt from registration.
Rule 503 A notice of sales must be filed no later than 15 days after the first sale of the securities.
Rule 504 According to the SEC, “Rule 504 of Regulation D exempts from registration the offer and sale of up to $5 million of securities in a 12-month period.”
Rule 505 According to FINRA, “Rule 505 provides an exemption … for limited offerings for which the aggregate offering price of securities within a 12-month period does not exceed $5,000,000. Rule 505 permits an offering to an unlimited number of ‘accredited investors’ and up to 35 non-accredited investors” but reselling is restricted.
Rule 506 According to FINRA, “Under Rule 506 of Regulation D, firms may employ general solicitations and advertising when offering private placements, provided that all purchasers of the offering are accredited investors.”

 

Companies can raise an unlimited amount of money if they meet certain exceptions, which are outlined at https://www.investor.gov/additional-resources/general-resources/glossary/rule-506-regulation-d.

 

This rule includes the so-called “safe harbor” provision, which assures companies they are exempt from registration if they meet certain requirements (including being available to answer questions posed by prospective investors).

Rule 507 According to the Securities Act of 1933, those who fail to comply with Rule 503 shall be disqualified from receiving an exemption under Rules 504, 505, and 506.
Rule 508 According to the Securities Act of 1933, those who fail to comply with Rules 504, 505, 506 will still receive proper exemptions if the failure to comply was deemed insignificant or if they made a good faith effort to comply.

 

The SEC is considering changes to Rule 501 that could affect who can qualify as an accredited investor, according to a Law360 article from July 16, 2019. Since the rule was enacted in 1983, there has only been one significant change: in 2010, the SEC decided that the value of one’s home could not be counted as part of the $1 million required net worth. This made it harder for many people to qualify as accredited investors. At the same time, however, the provision that one have an annual income of $200,000 or more has not changed since 1983. $200,000 in 1983 would be worth about $530,000 today. Thus, any people now qualify as accredited investors simply because of inflation.

A recent SEC concept release found that “individuals with advanced degrees represented 38% of the eligible accredited investor pool, but only 13% of the general population, while those with no college degree represented 54% of the population but only 17% of the eligible accredited investor pool.” Furthermore, most accredited investors are clustered in the Northeast and West. These statistics have led some to decry the “elitist” nature of alternative investments.

While the financial gains that the stock market can provide should be open to all, we cannot forget that there are also losses to be had. Thus, accredited investors should be properly vetted to ensure that no one falls victim to fraud. The SEC is asking for comments, however, on how that vetting should occur. Some have proposed financial literacy, as opposed to pure income, as a more equal way to determine if one is ready to invest in private placements.

If you have questions about Regulation D (also known as “Reg. D”), “alternative investments,” including private placements, don’t hesitate to contact the experienced securities attorneys at Fitapelli Kurta at (877) 238-4175 or info@fkesq.com.