Flexible Disclosure Options Under Regulation D – Rule 504
In general, any securities to be offered or sold in San Diego or in California must be registered to comply with both federal and California securities laws — the Corporate Securities Law of 1968 (Corp. Code, §§ 25000-25707) and the federal Securities Act of 1933 (15 U.S.C. § 77b).
Registration is a complex and expensive process.
However, Regulation D provides exemptions from registration for various securities if certain conditions are satisfied. The two main exceptions are provided by Rule 504 and 506 (Rule 505 was abolished in 2016). This article discusses one advantage of Rule 504 over Rule 506: no specific disclosure requirements.
San Diego Corporate Law: Regulation D – Rule 504
Effective in January 2017, the federal Securities and Exchange Commission (“SEC”) amended Regulation D Rule 504 to increase the maximum dollar amount of securities that may be sold to $5 million. The previous limit of $1 million made the former Rule 504 essentially useless as a tool for raising viable amounts of capital. In general, an offer and sale of securities is exempt from registration pursuant to Rule 504 if:
- The dollar amount of securities sold in the offering is $5 million or less in any 12-month period
- The offering is not advertised generally
- There are no “bad actors” involved
- Resale of the securities are restricted
If the securities are being sold in California, the offering must also comply with California Exemption 25102(f) which has additional limitations. In general, section 25102(f) limits the offering to 35 investors and all investors must be accredited or have a pre-existing relationship with the offeror.
Those offering and selling securities under Regulation D must complete and file Form D with the SEC within 15 days after the first sale of securities under the offering. See general information page from the SEC here. See here for Form D. Similarly, for offerings sold in California, within 15 days after the first sale, the Section 25102(f) Form needs to be filed with the California Department of Business Oversight.
San Diego Corporate Law: Rule 504 and Flexible Disclosure Options
Note that Rule 504 does not have any specific disclosure requirements. This is an advantage to making a private offering under Rule 504 versus Rule 506. Rule 506 has specific disclosure requirements that can be expensive to produce and provide. As examples, under Rule 506, an offeror must prepare and include the following:
- Financial statements – unaudited for offerings up to $2 million, audited for those above $2 million
- Non-financial statement information
- Information on all businesses involved and the transaction particulars if the offering is made as part of business combinations and exchange information offers. If securities are issued in a business merger and acquisition transaction — essentially the voluminous requirements of a Form S-4 registration statement
These burdensome disclosure requirements often make the participation of non-accredited investors in a Rule 506 offering impracticable, particularly in the M&A context.
However, as a practical matter and as a legal matter, the Rule 504 no-specific-disclosure advantage does not mean that no disclosures should be made. Rather, Rule 504 provides flexible options allowing streamlined and less-expensive disclosures. Caution is in order since both federal and California securities laws punish securities fraud where false statements are made or where material information is omitted.