Over the past year or so, FactRight has seen an increase in the number of private placements in the retail space alternative space as sales of public, non-traded products decline. While many in the industry have a good understanding of the differences public and private investment programs, it is easy to overlook the actual regulation that allows for private placements, Regulation D, and the impact the regulation has on program design.
Over the next few weeks, I’ll explore various Reg D-related topics in a series of posts on the FactRight blog. Today, I’ll start with a foundational overview of Reg D, which underwent rule changes in 2016 (which became effective in 2017). Note that these rule changes affected Rules 504 and 505, which don’t pertain to the vast majority of syndicated programs in the retail space.
What is Regulation D?
Under the Securities Act of 1933, any offer to sell securities must be registered with the SEC or meet an exemption to registration. Regulation D securities are issued under one of two rules that provide exemptions to the registration requirement. These rules allow issuers to sell securities without registering the securities with the SEC. Most fundamentally understood, Reg D is not an investment structure or a strategy—it provides an exemption from registration.
What are the available exemptions?
The amended Reg D consists of two rules that provide exemptions to registration: Rule 504 and Rule 506. Under each of these rules, investors receive restricted securities. This means that investors cannot generally sell the securities for certain time periods without registration.
Every Reg D program that FactRight has reviewed for our clients has been issued pursuant to a claimed exemption under Rule 506; however; I’ll briefly touch on Rule 504 (and the old Rule 505) for informational purposes.
As amended, Rule 504 provides a registration exemption for companies that offer up to $5 million in securities in any 12-month period. The issuer of a 504 offering may engage in general solicitation, meaning that they can advertise their securities to the general public, as long as investors are accredited. The former Rule 505 (which had allowed raises up to $5 million under its provisions) has been repealed, rendered superfluous when the limit under Rule 504 was raised from $1 million to $5 million through the recent rule changes.
How does Rule 506 work?
Companies relying on the 506 exemption can raise an unlimited amount of money under one of two separate exemptions: 506(b) and 506(c). Currently and historically, the most commonly used in the retail syndication space has been 506(b). The 506(b) exemption prohibits the issuer from engaging in general solicitation. This exemption permits the sale of securities to an unlimited number of accredited investors and up to 35 non-accredited investors. Under 506(b), the issuer can decide what type of information to provide accredited investors, but they are required to provide non-accredited investors with disclosure documents similar to what is required under registered offerings. In abundance of caution (as a best practice), issuers almost always make 506(b) offerings available only to accredited investors, and these investors are supplied with offering disclosures (through a private placement memorandum) that Rule 506 only technically requires for non-accredited investors.
How is 506(c) different than 506(b)?
Rule 506(c) was also created relatively recently, as part of the 2012 JOBs Act. 506(c) syndications are much less common than 506(b) in the retail space that we cover, but are slowly growing in numbers. The most important difference between the 506(b) and 506(c) provisions is that 506(c) allows for general solicitation and advertising for the offering, while 506(b) does not. Another difference between the two exemptions relates to the accredited investor requirement, under which all investors must be accredited investors under 506(c). That provision places unique requirements on the issuer to verify accredited investor status.
Do Reg D Issuers have filing requirements?
While issuers that rely on a Reg D exemption do not have to register their securities with the SEC, they do have to file a Form D. Form D is a brief notice that contains a limited amount of information about the offering and issuer’s promoters, which is publicly available on the SEC’s EDGAR website. Generally, the issuer needs to file Form D with the SEC within 15 days of the first sale of securities.
Look out for upcoming blog posts on other private placement-related topics, including typical offering terms for syndicated deals, customary fees and expenses, distribution waterfalls and sponsor carried interests, and other material due diligence considerations for private placement offerings.