Do State Blue Sky Laws Apply To Regulation D Offerings?
Issuers are sometimes unaware of the state laws that apply to offerings that are exempt under the federal securities laws. The purchase or sale of a security be subject to a registration statement under the Securities Act of 1933 (the “Securities Act”) or exempt from registration. An exemption at the federal level does not eliminate the obligation to comply with state blue sky laws in all circumstances. Federal preemption depends upon the exemption relied upon.
The most common exemptions from registration under the Securities Act are found in Regulation D which provides three separate exemptions: Rules 504, 505, and 506. The exemption relied upon by an issuer will depend on several factors including the amount of capital the issuer wishes to raise and whether it can raise from accredited investors, which is defined in Rule 501 of Regulation D. Generally, an accredited investor is an investor with a net worth of at least $1 million, not including their primary residence, or an investor with income of at least $200,000 in annual income for the two prior years or $300,000 with their spouse. Securities sold pursuant to Regulation D are restricted and thus cannot be resold by the investor without registration or a resale exemption from registration such as the “safe harbor” of Rule 144.
Rule 504 allows a company to raise up to $1 million in any 12-month period. The company may sell the securities to an unlimited number of accredited or non-accredited investors so long as they remain under the cap of $1 million. Rule 504 offerings are subject to state blue sky laws which obligate the issuer to comply with the registration requirements of each state in which investors are located. The Rule 504 exemption prohibits general solicitation, which means the company must have a substantive preexisting relationship with investors.
Like Rule 504, the Rule 505 exemption is rarely used. Issuers may sell up to $5 million of securities to an unlimited number of accredited investors and up to 35 non-accredited investors. General solicitation is prohibited and issuers must comply with the state blue sky laws where investors are located.
The Rule 506 exemption is the most commonly used exemption. A Rule 506 exempt offering is not required to be registered at the state level, and states cannot impose additional requirements on issuers, beyond submitting a notice filing and paying filing fees. The JOBS Act divided Rule 506 into two separate exemptions, 506(b) and 506(c). Under Rule 506(b), general solicitation is prohibited, and issuers may offer securities to an unlimited number of accredited investors and up to 35 non-accredited investors. The issuer must “reasonably believe” an investor is an accredited investor. The SEC has not imposed any special requirements on the verification process in Rule 506(b) offerings.
Rule 506(c) allows general solicitation and advertising, but a company must take “reasonable steps” to ensure all investors are accredited investors. (The number of investors is unlimited but they must all be accredited investors. Issuers using Rule 506(c) must use reasonable steps to verify all investors are accredited.
Issuers conducting any offer or sale of securities must consider state blue sky laws that may be relevant to their offering. Securities offerings under Rule 506 are deemed to be covered securities under the federal law, which preempts the states from substantively regulating Rule 506 offerings under state securities or blue sky laws. Despite this federal preemption, states may require the filing of a Form D, Consent to Service of Process and the payment of a filing fee. Securities offerings under new Rule 506(c) are “covered securities”. As such, State securities commissioners and regulators are precluded from applying their blue sky laws to offerings of securities that involve general solicitation or general advertisement under Rule 506(c), provided that the issuer complies with the requirements of the exemption and notice filing and fee payment requirements in their state.
Some states have existing laws prohibiting issuers from making unregistered offerings to residents of their state using the Internet. Because Rule 506(c) offerings constitute covered securities, states cannot prohibit the use of the Internet in connection with an offering that complies with the requirements of Rule 506(c). Companies should ensure compliance with state law requirements to avoid problems during their going public transactions.
It should be noted that issuers that have previously relied on state limited offering exemptions rather than federal preemption as covered securities will no longer be able to utilize a limited offering exemptions if they conduct a Rule 506(c) offering.
States remain authorized to enforce anti-fraud provisions and regulate financial intermediaries and finders even after Rule 506(c). Issuers should remember that the Rule 506(c) exemption does not eliminate the broker-dealer registration provisions and both issuers and brokers must comply with federal and state registration provisions.
For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com. This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.
Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
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