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Regulation D, Rule 506 Private Placements

The most common exemption from registration is the private offering. Private offerings are generally sold through a legal disclosure document known as a private placement memorandum. Although private offerings are generally exempt from federal and state registration requirements, complex “notice” filing requirements still exist and many states further qualify a private offering. Finally, private offerings may not be sold by means of general advertising or solicitation. Normally a preexisting relationship between the company and the investor is required. Most entrepreneurs do not know enough qualified investors to finance a private offering. It is therefore easy to inadvertently turn a private offering into a public one, which then defeats the exemption and requires registration and/or return of investors’ money.

The SEC has created a “safe harbor” for private offerings. Regulation D (17 C.F.R. Sec. 230.500 et. seq.), Rule 506 allows a company to sell an unlimited dollar amount of securities to an unlimited number of “accredited” (generally wealthy investors and institutions, see Rule 501) investors, and to up to 35 non-accredited investors. While Reg. D provides burdensome disclosure requirements for offerings over $7.5 million such as expensive and time consuming audited financial statements, these requirements are lessened if the offering is limited to accredited investors. It therefore is possible under 506D when limiting investors (actual purchasers, not offerees) to those who are accredited to use a detailed business plan in lieu of a formal private placement memorandum or prospectus. See Reg. D, Rule 502(b)(1).

State Law

Reg. D offerings must still comply with minimal state regulations (“blue sky laws”). However, as “federally covered securities” Rule 506 offerings are not subject to burdensome state qualifications (15 USC 77r(a)(1-3) for the offering itself, only to state notice filings and fee requirements. See 15 USC Sec. 77r. States do, however, maintain antifraud jurisdiction for material misstatements or omissions in 506D offerings. The question becomes how far this antifraud authority extends, and whether it may eclipse the preemption intended by Congress in 15 USC 77r(a)(1-3)?

The SEC has taken the position that “states may not, however, indirectly regulate . . . activities . . . by enforcing state requirements that define ‘dishonest’ or ‘unethical’ business practices unless the prohibited practices would be fraudulent absent the requirements” (emph. added). SEC Rel. No. IA-1601 (12/20/96)—Proposed Rules Implementing Amendments to the Investment Advisors Act of 1940—interpreting provision in the Investment Advisors Act analogous to 15 USC 77r©(1) by citing the legislative history of 15 USC 77r©(1). The SEC in footnote 23 to the above cited the following legislative history of 15 USC 77r©(1): “The House report discussing that section explained that ‘in preserving state laws against fraud and deceit . . . the Committee intends to prevent the states from indirectly doing what they have been prohibited from doing directly . . . The legislation preempts the authority that would allow states to employ the regulatory authority they retain to reconstruct in a different form the regulatory regime that section 18 (15 USC 77r) has preempted.” H.R. REP. NO. 622, 104th Cong., 2d Sess. 34 (1996).

While states may investigate 506D offerings for “fraud”, they may not use that regulatory authority to emasculate the preemption intended by 15 USC 77r(a)(1-3). States may not use investigation of fraud as a pretense to dictate the terms of an offering document (or business plan used as such). Neither may states subtly define “fraud” in excess of protections accorded by federal law which would result in 506D offerings having to comply with the varying “disclosure” and “materiality” standards of the 50 states. This construction is supported not only by Congressional and SEC interpretation of federal law, but compelled by Commerce Clause analysis under the US Constitution.

There is little if any case law interpreting 15 USC 77r©(1) (state’s antifraud authority under 506D). However, as both Congress and the SEC have taken the position state antifraud jurisdiction may not be used as a pretext to micromanage a 506D offering, that position is the correct interpretation of the law. A federal agency’s interpretation of a federal statute the agency is to administer is to be accorded substantial deference whenever its interpretation provides a reasonable construction of the statutory language and is consistent with legislative intent. Securities Indus. Assn. v. FRS, 468 US 137 (1984). In reviewing an agency’s construction of a statute, first the statute and legislative history are examined. If either or both of these support the agency’s interpretation of a statute, the inquiry ends there and the agency’s interpretation is adopted. If Congress has not directly spoken to the precise question at issue, the question for an interpreting court is whether the agency’s interpretation of a statute is based on a permissible construction of the statute. Chevron, USA, Inc. v. Natural Resources Defense Council, Inc., 467 US 837 (1984).

Rules Regarding Solicitation of Investors

For emerging as well as many established companies, the best way to raise capital is through a Reg. D, Rule 506, offering limited to accredited investors. The only remaining problem is Reg. D’s prohibition (see Rule 502) on Rule 506 offerings utilizing any form of “general solicitation or advertising”.

Of course, the questions are what is and what is not “general solicitation or advertising”, and whether or not it is possible to raise capital from commercial investor lists without violating this prohibition. It is pertinent that Rule 502 does not ban any “solicitation or advertising”, only “general” solicitation or advertising; by comparison, “limited” solicitation or advertising is permitted. The challenge is to delineate between “general” and “limited” advertising or solicitation. A brief review of relevant SEC opinions on these matters is in order.

In H.B. Shaine & Co., Inc., No Action Letter dated May 1, 1987, the SEC staff indicated that the distribution by a securities dealer of questionnaires to prospective accredited investors to determine their suitability to participate in private offerings would not be a “general solicitation or advertisement”. This view was premised upon several factors, including the use of a generic questionnaire and upon the elapse of a sufficient period of time between the completion of the questionnaire and the contemplation or inception of any particular offering. 45 days has been held to be a “sufficient period of time” to establish a “substantive preexisting relationship” justifying offering securities to these prospective accredited investors. See E.F. Hutton, SEC No-Action Letter (Dec. 3, 1985).
Lamp Technologies, Inc., SEC No Action Letter dated May 29, 1997, provides more recent guidance regarding the establishment of substantive preexisting relationships to avoid general advertising and solicitation. The SEC consented to a 30 day waiting period following the completion of a generic accredited investor questionnaire by a third party list provider (here a web-site matching investors and issuers of securities) before an investor could invest in a company’s offering. Further, once the thirty day period passed an investor-member of the web-site could invest in any security that had been previously posted, not just those posted after their membership had become effective. Finally, the SEC has stated that “we also would not object if similar screening procedures were used by the publisher of a private fund directory (i.e., commercial list provider—emph. added), distributed in paper, rather than in electric format.”

Use of Brokers, Finders and Qualified Lead Providers

Brokers are persons or firms who help an issuer of securities to “sell” investment to investors. Brokers are salespeople, and actively attempt to induce investors to purchase an issuer’s securities. In the US a broker has to be registered with the SEC, and various states; there are broker qualification requirements in the UK, Canada, and other nations. By contrast, an investor “finder” does not act as a salesperson, but limits his/her activities to “matching” prospective investors with companies seeking investment. Just as a dating service merely matches prospective couples but does not attempt to determine the outcome of the parties’ dating relationship, or whether or not the parties end up getting “married”, a “finder” merely matches potentially suitable parties.
A question is raised as to whether or not a finder has to be registered as a broker-dealer in the US under federal law. Generally speaking, a finder does not have to be registered as a broker-dealer if a finder’s activities are limited. A “broker” under the Securities Exchange Act is “any person engaged in the business of effecting transactions in securities for the account of others.” The Commission has found activities such as (a) participating in presentations or negotiations, (b) making any recommendations concerning securities, (c) receiving transaction-based compensation, (d) structuring a transaction or making recommendations regarding the nature of the securities, whether to issue securities or the assessed value of securities sold, and (e) continuing involvement in sales of securities to trigger broker-dealer registration obligations. See John R. Wirthlin, SEC No-Action Letter dated January 19, 1999; Paul Anka, SEC No-Action Letter dated July 24, 1991; Caplin & Drysdale, Chartered, SEC No-Action Letter dated April 8, 1982; John DiMeno, SEC No-Action Letter dated October 11, 1978; and David A. Lipton, Broker-Dealer Regulation, §1.03, at 1-10 (15 Securities Law Series 1988).

However, no one factor is determinative. Finders may avoid registration by limiting their activities to introducing prospective investors to an issuer and basing their compensation on a flat fee basis. Richard S. Appel, SEC No-Action Letter dated February 14, 1983. While the SEC has taken the position that transaction based compensation is “the hallmark of broker-dealer activity” and that “any person receiving transaction-based compensation in connection with another person’s purchase or sale of securities “typically” (emph. added–see also footnote 3’s use of “generally”) must register as a broker-dealer (See SEC No Action Letter dated May 17, 2010 re: Brumberg, Mackey & Wall, PC), a commission is not a definite indication that the finder should be registered. Carl L. Feinstock, SEC No-Action Letter dated April 1, 1978; see also Footnote 1 below. The key to remaining a finder, and not acting as a broker thereby requiring registration as a broker, is to limit one’s activities to the introduction of prospective investors to the issuer. A finder should never be involved in structuring a transaction—which is the province of either a broker or an attorney, or in inducing a prospective investor to invest in a specific offering—which is the province of a broker or an issuer. The SEC staff has recognized that “individuals who do nothing more than bring persons together and do not participate in negotiations or settlements probably do not fit the definition of a “broker” or a “dealer” and would not be required to register. On the other hand, individuals who play an integral role in negotiating and effecting transactions are required to register with the Commission.” Gary L. Pleger, Esq., SEC No-Action Letter dated October 11, 1977; IMF Corp., SEC No-Action Letter dated May 15, 1978. IF AN ISSUER OF SECURITIES DETERMINES TO USE A “FINDER” TO OBTAIN PROSPECTIVE INVESTORS, LEGAL ADVICE IS CRITICAL IN DRAFTING A FINDER AGREEMENT TO AVOID THE FINDER BEING FOUND TO BE AN UNREGISTERED BROKER!!

Finally, state law may also purport to regulate finder activities. A question exists as to whether or not state law may regulate the activities of finders with respect to federally covered securities like SEC Reg. D Rule 506 offerings. While it appears that 15 USC 77r may prevent states from regulating finders in the context of 506D offerings, there is little if any case law that definitively settles the matter. Some states continue to regulate the activity of finders (e.g., defining what finders may or may not do; requiring finders to be “registered” with the state; etc.) for 506D offerings. See Gray, Michael B. of Neal, Gerber, and Eisenberg, LLP, “Unregistered Finders: A Trap for the Unwary”, The Blue Sky Bugle (A newsletter for blue-sky lawyers published by ABA Committee on the State Regulation of Securities), Vol. 2009, Number 3, pages 8 – 11 (Sept. 2009) found at http://www.abanet.org/buslaw/committees/CL680000pub/newsletter/200909/200909.pdf. Notwithstanding the willingness of some states to regulate finder activities with respect to federally covered securities like 506D offerings, a strong argument exists that 15 USC 77r preempts states from doing so. As discussed supra (state law) Congress and the SEC have taken the position that states may not use their preserved antifraud jurisdiction over federally covered securities to regulate these offerings. The same argument applies to the regulation of finders in the context of federally covered securities offerings. Applying standard rules of construction with respect to federal statutes (See Kim, Yule, Legislative Attorney American Law Division, “Statutory Interpretation: General Principles and Recent Trends”, CRS Report for Congress, Updated August 31, 2008 found at http://www.fas.org/sgp/crs/misc/97-589.pdf. With respect to 506D offerings 15 USC 77r provides that states shall not “directly or indirectly prohibit, limit, or impose conditions upon the use of . . . any offering document that is prepared by or on behalf of an issuer” or “directly or indirectly prohibit, limit, or impose conditions, based on the merits of such offering or issuer, upon the offer or sale of any security” (federally covered securities—inclusive of 506D offerings). The only exceptions are the preservation of state antifraud jurisdiction, and blue-sky filings and fees. In reference to the cited Yule article, the plain meaning of the statute appears to prevent states from regulating finders and brokers in 506D offerings (page 39). Legislative history in the passing of the statute—cited supra in the context of state antifraud jurisdiction—supports a broad preemptive intent by Congress (page 45). So does the SEC’s interpretation of the broad preemptive effect of the statute (discussed supra in the context of state antifraud jurisdiction), and the SEC’s existing scheme of regulating brokers but not finders (not requiring the latter to be “registered” yet going so far as to include “finder compensation” in its Form D)—pages 22 and 23. The inclusion of exceptions in the statute (fraud, blue-sky filings & fees) and not others (e.g., state jurisdiction of finders) would reasonably preclude a finding of any other exceptions to preemption except those so passed by Congress (“Where Congress explicitly enumerates certain exceptions to a general prohibition, additional exceptions are not to be implied, in the absence of contrary legislative intent.”—pages 16 & 17). “Although ‘it has long been established that the title of an Act cannot enlarge or confer powers, the title of a statute or section can ‘aid in resolving an ambiguity in the legislation’s text’.”—page 31. 15 USC 77r is entitled “Exemption from State Regulation of Securities Offerings”, and Section C therein that enumerates the exceptions is entitled “Preservation of Authority”. While headings are not determinative, if there is any ambiguity or doubt as to the scope of 15 USC 77r the headings shed light on Congress’ intent of preempting state regulation of 506D offerings—except in so far as they preserved state antifraud jurisdiction, and blue-sky filings/fees. In sum, while there is no definitive law settling the issue, more likely than not the more reasonable interpretation of 15 USC 77r is that it prevents states from regulating the activities of finders in the context of 506D offerings. It is worth mention that while it is reasonable for the government to regulate commercial activities such as the buying and selling of securities, there is a question if the regulation of mere finders (those limiting their activities to merely introducing issuers to potential investors) would be a violation of the First Amendment’s free speech and freedom of association protections. That being said, it may nonetheless be advisable to comply with reasonable state requirements for finders. IF AN ISSUER OF SECURITIES DETERMINES TO USE A “FINDER” TO OBTAIN PROSPECTIVE INVESTORS, LEGAL ADVICE IS CRITICAL IN DRAFTING A FINDER AGREEMENT TO ENSURE COMPLIANCE WITH APPLICABLE STATE FINDER LAW.

Finally in the other nations discussed below, broker/finder distinctions are not as relevant. That being said, those assisting a Company in foreign offerings from the United States may be subject to broker registration in the United States. See Securities Exchange Act Release No. 39779 (March 23, 1998). Accodingly proper legal guidance is advisable with respect to finder/broker participation in exempt multi-national offerings.


It is permissible under 506D to utilize commercial investor lists 30 days or older that have been pre-qualified as such by the list company/finder/broker/qualified lead provider having contacted the investor, and to utilize those lists to contact investors. Similarly, if an appropriate preexisting relationship has been established, traffic to a company’s web-site may be used as a pool of investors. A detailed business plan may be used in lieu of a private placement memorandum–if investors are limited to those who are “accredited”. The offering must still remain “confidential”, meaning that investors receiving your documents must be warned not to pass it on to others. Use of brokers, finders, and qualified lead providers if legally structured properly is permissible. OTHER NATIONAL EXEMPTIONS

Regulation S: Prior to selling abroad, a US issuer must ensure it complies with SEC Regulation S (17 CFR 203.901 et. seq.), thereby taking an overseas offering outside the purview of US federal and state regulators. The US Patriot Act must also be complied with as applied to funds from overseas. Various national exemptions we work with include the following:
United Kingdom: Section 21(a) of the UK Financial Services and Markets Act 2000 (the “Act”) provides that “a person must not, in the course of business, communicate an invitation or inducement to engage in investment activity” (the “financial promotion restriction”) unless he complies with the Act. Effective July 1, 2005 Parliament approved further interpretations of the Act known as the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005—the “Order”. Section 48 of the Order exempts from the Section 21(1) financial promotion restriction solicitations made to persons reasonably believed to be “certified high net worth individuals” under specified terms and conditions. “Non-real time communications” such as e-mails and letters are allowed; provided, certain notices are provided. “Real time communications” such as telephone calls are allowed; provided, such contacts are “solicited” by the prospective investor.

Canada: Canadian National Instrument 45-106 allows for offers and sales of securities to individual Canadian accredited investors as defined in 45-106; as with the UK, the US Patriot Act and SEC Reg. S must be complied with for Canadian offerings. After receiving Canadian investment, there are provincial filings similar to US blue-sky state filings which must be made.

European Union: The “qualified investor” exemption of Directive 2003/71/EC of the European Parliament and the Council (November 4, 2003) allows for sales to “qualified investors”. As of March 25, 2010 Member States of the European Union include: Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxemburg, Malta, The Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom. Individual qualified investors include those who have asked to be considered as a qualified investor by his Member State, and in fact have been authorized by his Member State to be considered a qualified investor. Qualified investors must also fit at least two of the following criteria: The investor has carried out transactions of a significant size on securities markets at an average frequency of, at least, 10 per quarter over the previous four quarters; the size of the investor’s securities portfolio exceeds 5 million Euros; the investor works or has worked for at least one year in the financial sector in a professional position which requires knowledge of securities investment.

Switzerland: Certain limited investors may be solicited pursuant to Circular 03/01 “Public Marketing” of the Swiss Federal Banking Commission of May, 28, 2003, as amended or replaced from time to time.

China: Certain limited investors may be solicited pursuant to the nonpublic offering exemption of Chapter 2, Article 10 of the Securities Law of the People’s Republic of China, as amended.

Australia: The Australian sophisticated investor exemption as defined in Section 708(8)© of the Australian Corporations Act 2001, as amended (the “Act”), and Section 6.D.2.03 of the Australian Corporate Regulations 2001, as amended, and as further qualified in Section 88D of the Act and ASIC document PS154.

Japan: Pursuant to the Japanese Financial Instruments and Exchange Law (“FIEL”—revised April 1, 2008), the qualified institutional investor and 49 individual offeree exemptions are available.

Saudi Arabia: Private placement exemption pursuant to the Saudi Arabian Capital Market Law (high net worth & sophisticated investors—minimum investment 1,000,000 Saudi Arabian Riyals or $266.666.45 US as of April 13, 2011).

United Arab Emirates: Private placement exemption for wealthy and sophisticated investors.

Dubai International Finance Centre Free Zone (“DIFC”): While both Dubai and DIFC are geographically located within the United Arab Emirates (“UAE”), with respect to securities DIFC is a separate jurisdiction from the UAE and mainland Dubai. Pursuant to the DIFC Offered Securities Rules (“OSC”), offerings within the DIFR are exempt if limited to no more than 50 offerees in the DIFR within any 12 month period.

Bahrain: Exemption based on investments abroad by Bahranian nationals pursuant nonexclusively to bilateral trade and investment framework agreements; such a bilateral investment treaty exists with the United States (final siignature 9/19/99; execution date 5/30/01).

Brazil: Nonpublic offerings pursuant to Law No. 6.385 of December 7, 1976, as amended, Article 19, Paragraph 3 and 5, and the regulations promulgagted under Paragraph 5.

Israel: 35 offerees per year exemption as found in Section 15(a)(1) of the Israeli Securities Law of 1968, as amended, and the regulations promulgated thereunder.

Russian Federation: The “qualified investor” exemption as defined by Federal Law No. 39-FZ (“On Securities Market dated April 22, 1996, as amended).


(1) Whle the SEC has of late increasingly taken the position that transaction based compensation for finders “is the hallmark of broker-dealer” and that “any person receiving transaction based compensation in connection with another person’s purchase or sale of securities “typically” must register as a broker-dealer”, courts (who have the last word) have not gone so far. In Thompson v.Relation Serve Media, Inc., 610 F.3d 628 (11th Cir. 2010) Plaintiff’s claim that the Defendant used finders who were paid a 7% commission was dismissed for procedural reasons. Noteworthy, the Court did not opine that transaction based compensation for finders was per se improper. In Apex Global Partners, Inc. v. Kaye/Bassman International, Civil Action 3:09-CV-637-M (TNDC 2009)–citing Cornhusker Energy Lexington, LLC v. Prospect Street Ventures, 2006 WL 2620985, Fed. Sec. L. Rep. P 93974 (D. Neb. 2006), those courts held that “if (the finder’s) activities include: analyzing the financial needs of an issuer, recommending or designing financing methods, involvement in negotiations, discussion of details of securities transactions, making investment recommendations, and prior involvement in the sale of securities” registration as a broker-dealer would be required. However, “merely bringing together the parties to transacctions, even those involving the purchase and sale of securities, is not enough.” While the SEC may deny “no action relief” (i.e. assurances they will not bring enforcement action against finders receiving transaction based compensation), the SEC’s opinions are merely advisory. The SEC has yet to take enforcement action against a finder “merely bringing together the parties to (securities) transactions”, and absent Congress amending the securities law statutes is both unlikely to do so and, if it were, would be unlikely to prevail. That being said, finders and issuers must be extremely careful to properly limit finder activities to those of mere “matchmaking” of investors and issuers. If transaction based compensation is provided to finders, the best policy would be to strictly limit those arrangements to only individual finders who merely refer individual investors with whom those finders have strong personal relationships, and as per Brumberg, Mackey & Wall, PC (supra), not to accord transaction based compensation to “professional finders”. Proper legal guidance is critical in establishing effective and legal finder relationships.


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