Regulation D (Reg D) is a Securities and Exchange Commission (SEC) regulation that governs private placement exemptions, providing an effective route for smaller companies and entrepreneurs to raise funds quickly and cost-effectively without the need for public offerings. This regulation should not be confused with the Federal Reserve Board Regulation D, which limits withdrawals from savings accounts.
Key Takeaways
- Efficient Capital Raising: Regulation D lets companies conduct specific types of private placements to raise capital without needing to register the securities with the SEC.
- Clarity on Different Regulations: SEC Reg D is distinct from Federal Reserve Board Regulation D, which imposes limits on savings account withdrawals.
- Filing Requirements: Companies must file a Form D disclosure document with the SEC after the first securities are sold.
- Compliance: Those selling securities under Regulation D must comply with all applicable laws.
Understanding SEC Regulation D
Raising capital via a Reg D investment entails significantly less stringent requirements compared to a public offering. This approach enables companies to save time and issue securities they might otherwise be unable to. Importantly, investors buying these securities retain the same legal protections as other investors.
Even though Regulation D transactions are private offerings, they aren’t required to remain confidential. Depending on the specific rule being applied, offerings can sometimes be openly marketed to potential investors within a company’s network.
Requirements of SEC Regulation D
Regardless of the scale of the Reg D transaction, companies or entrepreneurs must adhere to the proper framework and disclosure documentation. Form D, which is filed electronically with the SEC after the first securities sale, contains significantly less information compared to a public offering’s exhaustive documentation. It mainly includes the names and addresses of the company’s executives and directors, as well as essential details regarding the offering.
Furthermore, issuers must provide written disclosures of all prior ‘bad actor’ events, such as criminal convictions, before the sale. This requirement diminishes the issuer’s ability to claim ignorance of any employee’s checkered past, ensuring greater accountability.
Transactions under Reg D are still subject to antifraud, civil liability, and other federal securities laws. Companies must also comply with pertinent state laws concerning the offer and sale of securities, including necessary disclosures and notices.
Exemptions Established by Regulation D
Regulation D comprises three principal rules that create exemptions for private offerings:
Rule 504
Rule 504 permits companies to sell up to $10 million in securities in a 12-month period without registration. Companies must file Form D within 15 days of the initial sale and comply with local regulations and laws where the securities are offered.
Some companies are ineligible for Rule 504, including:
- Investment companies
- Exchange Act reporting companies
- Companies with no specific business plan
- Companies planning mergers or acquisitions with unidentified partners
- Companies liable for ‘bad actor’ disqualifications
Rule 505
The SEC phased out Rule 505 in 2016, integrating its provisions into Rule 504. Rule 505 previously allowed companies to sell up to $5 million in securities within 12 months to unlimited accredited investors but limited non-accredited investors to 35.
Rule 506
Rule 506 allows companies to raise an unlimited amount of capital. Sellers must be available to answer buyers’ questions, and buyers receive restricted securities.
Under Rule 506(b), sales can be made to an unlimited number of accredited investors and up to 35 non-accredited investors. Unlike Rule 505, non-accredited investors must be considered ‘sophisticated,’ meaning they must have the financial or business acumen to assess the associated risks and rewards.
For sales to accredited investors, the company has discretion over the information disclosed. However, stricter disclosure rules, including financial statements, apply when selling to non-accredited investors.
Accredited Investor Exemption
The Securities Act of 1933 allows unregistered sales to accredited investors if the total offering price is under $5 million, although Regulation D does not specifically address this provision.
Limitations of SEC Regulation D
The benefits of Regulation D are exclusive to the issuer of the securities and do not extend to affiliates or later resellers. Additionally, the regulatory exemptions are limited to the transactions themselves, not the securities.
The Goal of Regulation D
The primary objective of Regulation D is to enable smaller companies, which may find registered public offerings unaffordable, to still access capital markets. The provisions also provide investor safeguards to verify that the company meets exemption requirements and is not involved in fraudulent activities.
What Is an Accredited Investor?
Accredited investors are individuals or businesses allowed to trade unregistered securities. To qualify, they must meet specific financial criteria. An accredited investor must have either a net worth exceeding $1 million or an annual income of at least $200,000 ($300,000 if married) over the prior two years, among other possible benchmarks.
Regulation A vs. Regulation D
While both Regulation A and Regulation D enable smaller companies to issue securities with fewer requirements than public offerings, Reg D requires most investors to be accredited. Regulation A allows for sales to non-accredited investors, but with limitations on their investment amounts.
The Bottom Line
Regulation D offers a vital provision for companies to raise capital without the lengthy and costly process of registering securities with the SEC. It enables smaller entities to leverage private placements, though they must still comply with all relevant state and federal laws.
Related Terms: Form D, accredited investor, non-accredited investor, private offering, securities.
References
- U.S. Securities and Exchange Commission. “Investor Bulletin: Private Placements Under Regulation D”.
- U.S. Securities and Exchange Commission. “Form D, Notice of Exempt Offering of Securities”.
- U.S. Securities and Exchange Commission. “Disqualification of Felons and Other Bad Actors from Rule 506 Offerings and Related Disclosure Requirements”.
- U.S. Securities and Exchange Commission. “Exemption For Limited Offerings Not Exceeding $10 Million—Rule 504 of Regulation D”.
- U.S. Securities and Exchange Commission. “SEC Adopts Final Rules to Facilitate Intrastate and Regional Securities Offerings”.
- U.S. Securities and Exchange Commission. “Accredited Investors – Updated Investor Bulletin”.
- U.S. Securities and Exchange Commission. “Accredited Investor”.
- U.S. Securities and Exchange Commission. “Regulation A”.
