What You Need to Know About the Regulation D Crowdfunding and Rule 504 and 506(c)

The Securities Act of 1933, as amended (the “Securities Act”), was created to protect investors by requiring the disclosure from companies that investors would need in order to decide whether to purchase an investment. The Securities Act does not address the quality of the securities sold in an offering; it enumerates the disclosures that must be made. The central principle it sets forth is that all securities sold in the U.S. must be registered or qualify for an exemption from registration.

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1. What You Need to Know About the Regulation D Crowdfunding and Rule 504 and 506(C)
2. The Securities Act of 1933, as amended (the “Securities Act”), was created to protect investors by requiring the disclosure from companies that investors would need in order to decide whether to purchase an investment. The Securities Act does not address the quality of the securities sold in an offering; it enumerates the disclosures that must be made. The central principle it sets forth is that all securities sold in the U.S. must be registered or qualify for an exemption from registration. For a company to register securities for sale, it must file a registration statement with the SEC. The registration statement must include a prospectus, which markets the stock to the public, financial reports, and additional information. Issuers can choose from a number of Securities Act registration forms, but initial offerings, used when companies first go public, are most commonly registered on Form S-1 or Form F-1. Two of the most common offering exemptions are contained in Rules 504 and 506(c) of Regulation D of the Securities Act. Rule 504 is known as Limited Crowdfunding because general solicitation and advertising may only be used in limited circumstances as discussed below. Rule 506(c) is also known as Accredited Crowdfunding because general solicitation and advertising may be used thus, appealing to a crowd. Most states have enacted rules known as blue sky laws to facilitate Rule 504 and Rule 506(c) offerings under federal Regulation D. The Securities Act of 1933 Creates the Regulation D Exemptions from SEC Registration
3. Both Rules 506(c) and 504 disqualify an issuer from conducting an offering in reliance on the exemption if the issuer or other relevant persons (such as underwriters, placement agents and the directors, officers and significant shareholders of the issuer) have been convicted of, or are subject to, court or administrative sanctions for securities fraud or other violations of the law. These provisions are known as “bad actor” or “covered persons” disqualification provisions. The Limited Crowdfunding exemption pursuant to Rule 504 of Regulation D allows companies to raise up to $5 million in a 12- month period if certain requirements are met. Rule 504 permits offers and sales to be made to both accredited and non-accredited purchasers, but there is a catch. Issuers must comply with state blue sky laws that apply to qualification and registration of the offering. In some states, this will require the filing and approval of disclosures comparable to those in a Securities Act registration statement. The Accredited Crowdfunding exemption pursuant to Rule 506(c) of Regulation D allows an issuer to raise an unlimited amount in a 12- month period. Rule 506 permits offers and sales to be made only accredited purchasers; however, the issuer may only accept funds from a purchaser it has taken reasonable steps to verify him as an accredited investor. Unlike Rule 504, Rule 506(c) preempts state laws. States may only require that the issuer pay a fee and submit a notice filing like Form D. Introduction to Regulation D and the Rule 504 & 506(c) Exemptions From SEC Registration
4. The Limited Crowdfunding exemption pursuant to Rule 504 of Regulation D allows companies to raise up to $5 million in a 12- month period if certain requirements are met. ➢ Rule 504 permits offers and sales to be made to both accredited and non-accredited purchasers, but there is a catch. Issuers must comply with state blue sky laws that apply to qualification and registration of the offering. In some states, this will require the filing and approval of disclosures comparable to those in a Securities Act registration statement. ➢ Rule 504 is not available to not available to companies subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, investment companies, or development stage companies that have no specific business plan or that intend to merge with or be acquired by an unidentified company. ➢ Offers and sales of securities in Rule 504 offerings may be made to an unlimited number of accredited and non-accredited investors. ➢ The issuer must file a notice with the SEC on Form D within 15 days after the first sale of securities in the offering. ➢ Rule 504 does not impose specific disclosure requirements; however, the anti-fraud provisions of both federal and state laws apply. ➢ Rule 504 will not be available to an issuer if certain “covered persons” are subject to Bad Actor disqualification. ➢ Securities sold pursuant to Rule 504 are restricted securities. Technical Requirements of the Regulation D Rule 504 Exemption
5. State securities laws impose their own registration and qualification requirements. In some states, the issuer must file registration type documents similar to those required by the SEC to register securities. Most states have adopted a uniform registration form for offerings relying on Rule 504 called SCOR (“Small Corporate Offering Registration”). If the issuer fails to comply with state blue sky law, its offering could be subject to enforcement actions by state securities regulators. Issuers conducting Rule 504 offerings are prohibited from using general advertising or solicitation unless the offering is conducted: ➢ exclusively in one or more states that require registration of the securities and distribution of disclosure documents approved by the relevant state, ➢ in one or more states that do not require registration of the securities, if the issuer registers the securities in at least one other state that requires registration and distribution of state- approved disclosure documents, and those documents have been delivered to all purchasers, including those purchasers in the state or states that do not require registration; or ➢ according to state law exemptions from registration of the securities that permit general advertising and solicitation so long as sales are made only to accredited investors. Regulation D Rule 504 State Blue Sky Requirements
6. The Accredited Crowdfunding exemption pursuant to Rule 506(c) of Regulation D allows an issuer to raise an unlimited amount from accredited investors in a 12- month period so long as it has taken reasonable steps to verify that the investors in the offering are accredited investor. Rule 506 has the following requirements: ➢ Unlike Rule 504, Rule 506(c) may be used by companies that are subject to the SEC’s reporting requirements. ➢ Rule 506(c) permits a company to raise an unlimited amount of capital from an unlimited number of accredited investors using general solicitation and advertising, enabling it to appeal to the “crowd” that characterizes a crowdfunding effort. ➢ The company must file a notice with the SEC on Form D within 15 days after the first sale of securities in the offering. ➢ Rule 506 will not be available to an issuer if certain “covered persons” are subject to Bad Actor disqualification. ➢ Investors in Rule 506(c) offerings will receive “restricted securities.” ➢ Although the Securities Act provides a federal preemption from state registration and qualification under Rule 506(c), the states still have authority to require notice filings and collect state filing fees. Technical Requirements of the Regulation D Rule 506© Exemption
7. Acceptable Methods of Accredited Investor Verification include (1) The issuer may review any IRS form that reports the purchaser’s income for the two most recent years and obtain a written representation from the purchaser that he or she has a reasonable expectation of reaching the income level necessary the current year. (2) The issuer may review certain types of documentation dated within the prior three months and obtain a written representation from the purchaser that all liabilities necessary to make a determination of net worth have been disclosed. ❖ With respect to assets: Bank statements, brokerage statements and other statements of securities holdings, certificates of deposit, tax assessments, and appraisal reports issued by independent third parties; and ❖ With respect to liabilities: A consumer report from at least one of the nationwide consumer reporting agencies. (3) The investor may obtain a written confirmation from a registered broker-dealer or investment adviser, attorney, or accountant stating that he took reasonable steps to verify that the investor is an accredited investor within the prior three months and determined that the investor is an accredited investor. (4) By engaging an accredited investor verification provider to verify the investors' status. Their procedures seem to be sufficient to meet the requirements of Rule 506(c), although the SEC declines to take a formal position. Regulation D Rule 506© Accredited Investor Verification Procedures
8. Rule 504 and 506(c) do not require the company to provide specific line item or other information to investors in order to claim the exemption; however, it is advisable to provide all material information to potential investors. Even though Rule 504 and Rule 506(c) do not require specific disclosures, states may do so. Companies should do the following when providing materials to investors: ➢ Require each of the company’s officers and directors to review all offering materials to ensure the information is true and complete and that all material information is disclosed. ➢ Require officers and directors to provide their biographies and background information in writing. ➢ Offering materials should be drafted with the assistance and participation of experienced securities counsel and the company’s accountants. ➢ Offering materials should not contain misstatements of material information or omissions of material facts, in order to make the disclosures not misleading. ➢ Offering materials should be amended if they become inaccurate, misleading or incomplete. ➢ Management should not make verbal or written representations to investors unless they are contained in the offering materials. ➢ The company should not make representations about increases in its stock price, or offer assurances about the company’s future prospects, profitability, or return on investment. Investor Disclosures in Regulation D Rule 504 and 506© Offerings
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