Series 82 – Private Securities Offerings Representative Exam Key Study Note Set Two

FINRA Rule 2210 governs communications with the public and dictates filing requirements. Generally, communications concerning private placement offerings are subject to specific filing requirements. Any communication that includes performance projections or contains claims that are not explicitly outlined in the offering documents must be filed with FINRA at least 10 business days prior to first use. Furthermore, if the communication is distributed to more than 25 retail investors within a 30-day period, pre-filing is required. Even if a communication is generally exempt, any exaggerated, unwarranted, or misleading claims would trigger a mandatory filing. The purpose of this requirement is to ensure that investors receive fair and balanced information and that member firms do not make unsubstantiated claims about potential returns or benefits.

The integration doctrine, under Regulation D, stipulates that multiple offerings may be considered a single offering if they are deemed to be part of the same plan of financing. This is crucial because if offerings are integrated, they must collectively meet the requirements of a single exemption. A Rule 506(b) offering, which allows for an unlimited amount of capital to be raised from an unlimited number of accredited investors and up to 35 non-accredited investors, could be jeopardized if integrated with another offering that violates the conditions of Regulation D. For example, if a company conducts a Rule 506(b) offering and, within six months before or after, conducts another offering that does not comply with the general solicitation ban or exceeds the number of permitted non-accredited investors when combined, the SEC might integrate the offerings, causing the Rule 506(b) exemption to be lost. This could lead to significant legal and financial repercussions for the issuer. SEC Release 33-4552 provides guidance on factors the SEC considers when determining whether to integrate offerings.

A placement agent in a private placement offering has a significant due diligence responsibility to ensure the accuracy and completeness of the information presented to potential investors. This responsibility stems from the need to avoid potential liabilities under Section 12 of the Securities Act of 1933, which imposes civil liabilities for material misstatements or omissions in connection with the offer or sale of securities. The placement agent must conduct a reasonable investigation to verify the information contained in the Private Placement Memorandum (PPM), including financial statements, business plans, and management representations. Failure to conduct adequate due diligence can result in liability if the PPM contains false or misleading information. The standard of reasonableness is often judged based on the circumstances, including the placement agent’s role, expertise, and access to information. A robust due diligence process typically involves independent verification of key facts, review of contracts and other relevant documents, and interviews with management and other relevant parties.

Regulation A and Regulation D provide different exemptions from the registration requirements of the Securities Act of 1933, each with distinct characteristics. Regulation A allows for offerings up to $75 million (Tier 2), permitting solicitation of the general public and requiring the filing of an offering statement with the SEC, subject to SEC review. Investors do not necessarily need to be accredited. Ongoing reporting requirements are also mandated. Regulation D, specifically Rule 506(b), allows for unlimited offering amounts but restricts solicitation to those with whom the issuer has a pre-existing substantive relationship or through a registered broker-dealer. While accredited investors can participate without limit, only 35 non-accredited investors are allowed, and they must be sophisticated. Rule 506(c) allows for general solicitation if all investors are accredited and the issuer takes reasonable steps to verify their accredited status. Regulation D has limited ongoing reporting requirements. The strategic implications involve balancing the need for capital, the desire to reach a broad investor base, and the willingness to comply with more extensive regulatory requirements. Regulation A is suitable for companies seeking broader market access, while Regulation D is often preferred for its flexibility and reduced compliance burden when targeting a specific group of investors.

In a Rule 506(b) offering under Regulation D, the absence of general solicitation is crucial. Establishing a “pre-existing substantive relationship” with potential investors is a key element in demonstrating compliance with this requirement. A pre-existing relationship means that the issuer or its agent knew the investor prior to the offering, and a substantive relationship implies that the issuer or its agent has sufficient information to evaluate the investor’s financial circumstances and investment experience. According to SEC guidance, a mere cold call or an advertisement would not create such a relationship. Acceptable activities might include prior business dealings, membership in a pre-existing investment club, or a referral from a trusted source where the issuer has taken steps to ensure the referrer has a sufficient basis for recommending the investor. The relationship must be more than just an introduction; it must involve a level of familiarity that allows the issuer to assess the investor’s suitability for the investment. Failure to establish a valid pre-existing substantive relationship can invalidate the Rule 506(b) exemption, leading to potential legal and regulatory consequences.

Regulation D imposes strict limitations on marketing and advertising for private offerings to prevent general solicitation, which is generally prohibited under Rule 506(b). Rule 506(c) provides an exception, allowing general solicitation, but only if all investors are accredited and the issuer takes reasonable steps to verify their accredited investor status. The use of electronic communications, such as social media, significantly impacts compliance. For Rule 506(b) offerings, any broadly disseminated advertisement or communication that could be construed as offering securities to the general public would violate the prohibition on general solicitation. This includes posts on social media platforms, mass emails, and publicly accessible websites. In contrast, Rule 506(c) allows for such communications, provided that the issuer adheres to the verification requirements for accredited investors. The SEC has provided guidance on what constitutes “reasonable steps” for verification, which may include reviewing documentation such as tax returns or brokerage statements. Failure to comply with these limitations can result in the loss of the Regulation D exemption and potential enforcement actions.

In a “best efforts” underwriting for a private placement, the placement agent agrees to use its best efforts to sell the securities on behalf of the issuer but does not guarantee the sale of any specific amount. The risk remains primarily with the issuer, as the offering is contingent on the placement agent’s ability to find investors. If the securities are not fully subscribed, the issuer may not receive the desired capital. Conversely, in a “firm commitment” underwriting, the placement agent agrees to purchase the entire offering from the issuer at a predetermined price, assuming the risk of reselling the securities to investors. This method provides the issuer with certainty of funding but shifts the risk to the placement agent, who must then successfully place the securities with investors. The choice between these methods depends on factors such as the issuer’s financial strength, the attractiveness of the offering, and the placement agent’s confidence in its ability to sell the securities. A firm commitment underwriting is generally more expensive for the issuer due to the increased risk assumed by the placement agent.

SEC Rule 147 provides an exemption from federal registration for offerings that are exclusively intrastate. To qualify, the issuer must be a resident of and doing business within the state. “Doing business” requires that at least 80% of the issuer’s gross revenues are derived from the state, 80% of its assets are located in the state, 80% of the net proceeds from the offering are intended to be used in the state, and the principal office of the issuer is located in the state. All offerees and purchasers must also be residents of the same state. For individuals, residency is determined by their principal residence. For businesses, residency is determined by the state of incorporation or principal place of business. Any resale to a non-resident within nine months from the date of the last sale by the issuer could jeopardize the exemption. This rule aims to facilitate financing for local businesses by local investors, but strict adherence to all conditions is crucial to maintain the exemption.

SEC Rule 506(b) provides an exemption from registration for private placements, allowing issuers to raise an unlimited amount of capital. It permits sales to an unlimited number of accredited investors but limits the number of non-accredited investors to 35. Critically, Rule 506(b) prohibits general solicitation or advertising of the offering. The issuer must have a pre-existing substantive relationship with any non-accredited investors solicited, or the investors must come through a broker-dealer with such a relationship. Issuers must provide non-accredited investors with specific disclosures, including information similar to that found in a registered offering prospectus, and an opportunity to ask questions and receive answers concerning the terms and conditions of the offering. Failure to comply with these requirements can result in the loss of the exemption and potential legal liabilities under Section 12 of the Securities Act of 1933.

FINRA Rule 5123 requires member firms acting as placement agents in private placements to have reasonable grounds to believe that the information contained in the offering documents is true and not misleading. This necessitates conducting due diligence, which includes reviewing financial statements, investigating management backgrounds, and assessing the viability of the business plan. When the member firm is also the issuer, the due diligence requirements are heightened. The firm must establish a process to ensure an independent review of the offering, often involving outside legal counsel or consultants. This is to mitigate the conflict of interest inherent in selling securities issued by the firm itself. Failure to conduct adequate due diligence can result in disciplinary action by FINRA and potential liability to investors under Section 12 of the Securities Act of 1933 for material misstatements or omissions.

Regulation S provides a safe harbor from the registration requirements of the Securities Act of 1933 for offers and sales of securities made outside the United States. To qualify, the offering must meet two general conditions: the offer and sale must be an “offshore transaction,” meaning no offer is made to a person in the U.S., and no “directed selling efforts” are made in the U.S. Directed selling efforts include activities such as advertising or promotional materials targeted at U.S. investors. Depending on the issuer and the securities being offered, additional restrictions may apply during a distribution compliance period to prevent flowback of the securities into the U.S. market. Resales back into the U.S. must be made pursuant to registration or an exemption, such as Rule 144A for qualified institutional buyers. Failure to comply with Regulation S can result in the offering being deemed a U.S. offering, requiring registration with the SEC.

FINRA Rule 2210 governs communications with the public by member firms. Retail communications, which are distributed to more than 25 retail investors within a 30-day period, require prior principal approval and must be filed with FINRA’s Advertising Regulation Department, unless an exemption applies. Correspondence, which is distributed to 25 or fewer retail investors within a 30-day period, does not require prior principal approval but is subject to supervision and review. Institutional communications are those distributed only to institutional investors, as defined by FINRA, and are exempt from the filing requirements and prior principal approval, though firms must still establish policies and procedures for their supervision and review. All communications, regardless of type, must be fair, balanced, and not misleading. Records of all communications must be maintained for three years from the date of first use. In the context of private placements, firms must be particularly careful to ensure that communications do not constitute general solicitation if the offering is being conducted under Rule 506(b) of Regulation D.

Section 3(c)(7) of the Investment Company Act of 1940 provides an exemption from registration as an investment company for private funds whose securities are offered and sold exclusively to “qualified purchasers.” This exemption allows sophisticated investors to participate in investment vehicles that might otherwise be subject to the Act’s regulatory requirements. A “qualified purchaser” is defined as either a natural person or a company that owns at least $5 million in investments, or an entity (such as a trust) owned directly or indirectly by or for two or more natural persons who are related as siblings or spouse (or former spouses), or direct lineal descendants by blood or adoption, who owns at least $5 million in investments. Additionally, any person, acting for its own account or the accounts of other qualified purchasers, who in the aggregate owns and invests on a discretionary basis, at least $25 million in investments also qualifies. This section aims to limit participation in these private investment vehicles to those with the financial sophistication and resources to evaluate the risks involved.

Regulation A provides an exemption from registration for smaller offerings, allowing companies to raise capital from the public with a lighter regulatory burden than a full registration. It has two tiers: Tier 1 allows offerings of up to $20 million in a 12-month period, while Tier 2 allows offerings of up to $75 million in a 12-month period. Tier 1 offerings are subject to state-level review, which can be time-consuming and costly. Tier 2 offerings are not subject to state-level review, but investors who are not accredited are limited in the amount they can invest to no more than 10% of the greater of their annual income or net worth. Companies conducting Tier 2 offerings are also subject to ongoing reporting requirements, including annual, semiannual, and current event reports filed with the SEC. Regulation A aims to provide smaller companies with access to capital while still providing investors with adequate disclosures and protections.