Rule 504 Of Reg D Could Become More Useful Following SEC Amendments
The Securities and Exchange Commission (SEC) recently adopted amendments to Rule 504 of Regulation D under the Securities Act of 1933 to increase the maximum amount of securities which may be offered and sold under the exemption from $1 million to $5 million. The rules also apply bad actor disqualifications to Rule 504, consistent with other rules in Regulation D.
Under the Securities Act, an offer to sell securities must be registered with the SEC unless its qualifies for an exemption from the registration requirements. Regulation D contains three rules providing such exemptions, allowing some companies to raise capital by selling debt or equity securities without having to register the securities with the SEC.
Currently, Rule 504 of Regulation D provides an exemption from the registration requirements for certain companies when they offer and sell up to $1 million of their securities in a 12-month period. The rule imposes certain conditions, including limitations on the use of general solicitation or advertising.
The issuer cannot be a development stage company that either has no specific business plan or that has indicated its business plan is to combine with an unidentified company (this is known as a blank check company). And the securities purchasers receive are “restricted,” meaning they cannot be resold without registration or an applicable exemption.
Amended Rule 504
The amended rule, effective January 20, 2017, retains the existing framework, while increasing the aggregate amount permitted to be offered and sold from $1 million to $5 million. The amendments also disqualify certain bad actors from participation in Rule 504 offerings.
In adopting the final rule, the SEC noted the amendments to Rule 504 make it largely similar to the seldom-used Rule 505 of Regulation D. For that reason, the SEC said it has decided to repeal Rule 505, effective May 22, 2017.
The SEC believes the changes to Rule 504 will “facilitate issuers’ capital raising efforts and provide additional investor protections.” To date, the rule has largely been underutilized, in part because of the low offering amount limit of $1 million. By increasing the amount, Rule 504 will likely become a more useful for smaller capital raising and M&A transactions.
Rule 504 can be advantageous for companies because it doesn’t require any particular disclosures to the investors participating in a Rule 504 offering. This is different from Rule 506 of Regulation D, which requires issuers must provide extensive disclosures if unaccredited investors are included in the offering. Due to the time and expense in creating such disclosures, inclusion of the the unaccredited investor often makes Rule 506 impracticable.
That’s not to say that no disclosures should be provided to investors in a Rule 504 offering; all material information that a reasonable investor would want to know should be disclosed as the Securities Act's anti-fraud rules still apply. It's also worth noting that unlike Rule 504, unlike Rule 506, does not preempt state substantive securities laws (aka "blue sky laws"). So, its utility is still relatively limited, despite the increased offering limit, except where an issuer plans to do an offering solely in one or two states.