SEC Rule 502: General Conditions to Be Met

The Securities Act of 1933 requires companies to register their offers and sales of securities with the U.S. Securities and Exchange Commission (SEC), a process that is public, costly, and time-consuming. Recognizing the need for more streamlined capital-raising methods, the SEC established Regulation D. This regulation provides several exemptions from registration requirements, allowing businesses to raise capital more efficiently. SEC Rule 502 sets forth four general conditions for most offerings under Regulation D, governing integration of offerings, required investor information, limitations on advertising, and restrictions on the resale of securities.

Integration of Offerings

The condition on integration is a concept designed to prevent companies from splitting a single large securities offering into several smaller ones to circumvent registration laws. The analysis determines if multiple offerings are so closely related based on facts and circumstances that they should be treated as one integrated offering.

To provide issuers with greater certainty, the framework includes several safe harbors. The most notable safe harbor provides that offerings made more than 30 calendar days apart will generally not be integrated, allowing a company to complete one exempt offering and begin a new one a month later.

Required Information for Investors

The required information an issuer must provide depends on the type of investors: accredited or non-accredited. If a company sells securities exclusively to accredited investors, who are individuals or entities meeting certain financial criteria, no specific information must be furnished.

The obligations change if an offering includes even a single non-accredited investor. In this case, the issuer must provide all purchasers, including accredited ones, with a detailed disclosure document at a reasonable time before the sale. The required non-financial information is similar to what is found in a registration statement and must be material to understanding the issuer, its business, and the securities. This includes a description of the business, risk factors, use of proceeds, and management.

Financial statement requirements are aligned with the disclosure rules for Regulation A offerings. For offerings up to $20 million to non-accredited investors, the issuer must provide financial statements similar to those required under Tier 1 of Regulation A. For offerings over $20 million, the issuer must provide audited financial statements as would be required for a Tier 2 offering.

Prohibition on General Solicitation

The rules for Regulation D prohibit the use of general solicitation or advertising to offer or sell securities in most offerings. Prohibited activities include advertisements in newspapers or magazines, broadcast communications, and seminars with publicly invited attendees. This ban also extends to unrestricted websites, public email blasts, and social media posts for a wide audience.

The principle is that private placements should be made to investors who have a pre-existing, substantive relationship with the issuer or its agents. This relationship must provide the issuer with a reasonable basis to believe the potential investor is sophisticated enough to evaluate the risks. The connection must be formed before the offering begins, and a simple self-certification from an investor is not sufficient.

An exception exists under Rule 506(c), which permits general solicitation, provided the issuer takes reasonable steps to verify that all purchasers are accredited investors. For other offerings, such as those under Rule 506(b), the prohibition on general solicitation remains fully in effect.

Limitations on Resale

Securities sold under Regulation D are “restricted securities” as defined in Rule 144. This condition limits their resale to ensure the offering does not become an indirect public distribution. Purchasers receive securities that cannot be freely sold in the public market and must either be registered with the SEC or sold under an applicable exemption.

The issuer must exercise reasonable care to ensure purchasers are not “underwriters” who plan to resell the securities to the public. This care includes several actions. First, the issuer must make a reasonable inquiry to determine that the purchaser is acquiring the securities for their own account. This is often done through a questionnaire in the subscription agreement.

Second, the issuer must provide written disclosure to each purchaser before the sale, informing them that the securities are restricted. Finally, the issuer must place a legend on the stock certificate or provide notice for uncertificated securities, stating the restricted status and the limits on transferability.