What Securities Laws and Regulations Govern Private Placements?

02 Jul 2018·Articles

The Federal government, and its regulatory agencies, are hard at work protecting investors.  Here’s a handy précis of the rules and regulations that Issuers follow when introducing Private Placements.

There is a broad body of law and regulations governing public Securities.  What surprises many is the extent of the same for private Securities.

Let’s review some of the principal laws and regulations that permit Companies to sell private Securities. 

One important item to note before proceeding: All Securities transactions, even exempt transactions described below, are subject to the antifraud provisions of the federal Securities laws, prohibiting false or misleading statements regarding the Company and the Securities offered.  Criminal, civil and administrative proceedings can be initiated by the government, and private parties also can bring actions under certain Securities laws.

U.S. Securities Laws Governing Private Securities

Securities Act of 1933: Private transactions have taken place for centuries.  However, following the stock market crash of 1929 and during the subsequent Great Depression, Congress initiated steps to prevent Companies from making unsubstantiated claims and promising unrealistic investment returns.

Out of this came the first U.S. Securities law, the Securities Act of 1933 (“The Act”).  Before its enactment, most states had written their own Securities laws (Blue Sky Laws) which still govern certain aspects of Securities sales.  The objectives of the Act were to:

  • Require that Investors receive financial and other significant information concerning Securities being offered for public sale; and
  • Prohibit deceit, misrepresentations and other fraud in the sale of Securities.

Securities Exchange Act of 1934 (“Exchange Act”)

The Exchange Act created the Securities and Exchange Commission (the “SEC”) that has oversight, as well as regulatory authority and disciplinary power, over the U.S. Securities industry, including brokerage firms and their reps, transfer agents, the nation’s Securities Self-Regulatory Organizations (“SROs”).  Those include the “New York Stock Exchange,” the NASDAQ Stock Market (“NASDAQ”) and the Chicago Board of Trade, as well as the Financial Industry Regulatory Authority (“FINRA”).

To accomplish the goals of the Act, Companies offering Securities to the public were required to register the Securities.  Note: registration simply ensures that adequate information is provided to Investors to enable them to determine the merits of the investment.  It does not mean that the government agency gives the Security its seal of approval.

Exemptions to Registration

The Act also allowed Securities to be sold privately, without SEC registration, through an exemption under Section 4(2) of the Act, which was subsequently amended to Section 4(a)(2).  A wide variety of transactions are included, such as private equity, Venture Capital, high-yield bonds and investment-grade debt.

Regulation D of the Securities Act of 1933: Private Securities Offerings

Regulation D (“Reg D”) was established by the SEC in the 1980’s to define more specifically a manner of privately offering Securities.  Most companies issuing private securities do so by following one of the Rules within Regulation D.  Its overall intent was to help smaller Companies access needed capital without the added expense of registering. 

Virtually any type of security can be offered to investors through a Regulation D private placement including Promissory Notes or equity interests (e.g. common stock, preferred stock or membership interest in a Limited Liability Company).

Rule 506(b) of Reg D

According to the SEC, Rule 506 is by far the most widely used exemption within Regulation D, accounting for an estimated 90 to 95% of all Regulation D offerings and the overwhelming majority of capital raised in transactions under Regulation D.

Rule 506(b) of Regulation D, which has been in effect for many years, enables Issuers to issue an unlimited amount of Securities so long as: 

  • The Securities are not offered in a general solicitation or through advertising, and
  • no more than 35 non-Accredited Investors participate in the Offering.  The non-Accredited Investors must have sufficient knowledge and experience to evaluate the merits and risks of the investment.

506(c) of Reg D – General Solicitations

Rule 506(c) Offerings became effective on September 23, 2013 (as a result of Title II of the JOBS Act of 2012) and allowed Issuers to broadly solicit and generally advertise an Offering, providing that:

  • All purchasers in the Offering are Accredited Investors;
  • The Issuer takes reasonable steps to verify purchasers’ Accredited Investor status (in Rule 506(b) offerings, self-verification is sufficient; and
  • Certain other conditions in Reg D are satisfied.

The purpose of the JOBS Act was to encourage small business funding and, in turn, spur economic growth through job creation, by amending several of the country’s Securities regulations.

In addition to Title II, the JOBS Act included Title III, which allows non-Accredited Investors to participate in Private Placements offered via approved internet portals.

Form D Filing

Under Regulation D, the SEC must receive the Offering documents from the Issuer within 15 days of the first purchase by an Investor.

Form D must also be filed by the Issuer in each state the securities are sold under Regulation D.

Whether a public or a private Company investment, Investors should thoroughly review the materials provided, ask educated questions about the Issuer, and understand the Security.  Now more than ever before, the federal statutes allow more individuals to invest in private equity and private debt Securities.