Under the Securities Act of 1933. there are 3 types of offerings of securities to investors:
- Registered Offerings:Section 5 reads: “(a) Unless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly… to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security…” 
- Exempt from Registration Offerings:Under Section 4(a)(2), “transactions by an issuer not involving any public offering [of securities]…” is exempt from the registration requirements of Section 5.
- Illegal Offerings:All other types of offerings of securities, non-registered under Section 5 or falling within one of the enumerated exemptions under the 1933 Act, are illegal.
In this module, we’ll examine what private offerings are, how they differ from public offerings and the features of private offerings.
Exempt Securities Offerings
The exempt securities issuance market is extremely large, totaling trillions of dollars annually in corporate and government securities. It is dominated by institutional buyers and sellers, such as mutual funds and venture capital firms. Sections 3 and 4 of the 1933 Act enumerate the types of offerings that are exempt from registration. The offer and sale of these securities are exempt from registration regardless of how they are offered, to whom they are offered, by whom they are offered and sold and where they are offered. Here are a few of the more widely used exemptions.
Under Section 3(a)(2), securities sold by the U.S. government, state and municipal governments and interests in employee benefits plans are exempt from registration. Securities offered by the US Treasury, such as US Savings Bonds, 10-year Bonds or US Treasuries, rely on this exemption. In addition, this Section exempts any security issued or guaranteed by the U.S. government. In 2018, the US Treasury issued $2.684 trillion of bonds and treasury securities.
Section 3(a)(3) exempts “commercial paper” that are issued by large US enterprises to raise funds for short-term operational needs. The Section exempts the offering and sale of a “note, draft, bill of exchange or banker’s acceptance which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions, and which has the maturity at the time of issuance not exceeding nine months.” The commercial paper market is huge, experiencing trillions of dollars in the value of issued securities. For example, at the end of March of 2019, the total commercial paper issued stood at $1.078 trillion.
Section 3(a)(5) exempts securities offered and sold by savings and loan associations that are supervised and examined by federal or state authorities such as the comptroller’s office. The Section also provides exemption for securities offered by farmers’ cooperative associations. While not as massive as the commercial paper or US debt markets, buyers and sellers under Section 3(a)(5) exemptions are primarily institutional in nature.
Section 4(a)(1) is probably the most used exemption. It provides a general exemption of all transactions involving the offer and sale of securities by “any person other than an issuer, underwriter or dealer.” This section allows for the everyday buying and selling of securities between ordinary investors on stock exchanges. Without this provision, the business of trading of securities could not be conducted. Note that to be listed in one of the national stock exchanges, a security must be registered via Section 5, which means that it must “go public” in the manner discussed in Modules 2 and 3. The Section 4(a)(1) exemption covers the offer and sale of securities by non-issuers, which covers the secondary stock market. The trading of stocks by non-issuers is, of course, a multi-trillion-dollar market.
Going from massive securities markets to smaller private markets, the next series of exemptions are listed in Sections 3(a)(9) through 3(a)(12), Section 3b and Sections 4(a)(1) through 4(a)(7). These exemptions are applied to individual cases, usually involving transactions between private investors. When these securities are resold, the seller must either register the securities or use an available exemption for the offer and sale of the securities.
The Private Placement Offering Exemption
A key exemption for private offerings is the one found under Section 4(a)(2) which exempts “transactions by an issuer not involving any public offering.” However, nowhere in the statutory language is the term “public offering” defined. Accordingly, the SEC and the courts have developed the rules that must be applied to determine the applicability of the “private placement exemption.” Without identifying what a public offering requires, the SEC and the courts have carved out a “safe harbor” for companies seeking to sell securities via private placement offering.
In the leading case of SEC v. Ralston Purina Co., the Supreme Court ruled the rationale behind the “private placement exemption” is that an exemption should apply where:
(A) A limited number of offerees (the potential buyers) are involved in an offer and sale of securities; and,
(B) Those targeted are sophisticated investors who can fend for themselves.
Following Ralston Purina, the SEC adopted rules to bring greater certainty to issuers who wished to bring private placement offerings to the market. These so-called “safe harbor rules,” were adopted pursuant to Regulation D.
Regulation D Exemptions
First, under Section 3(b) of the 1933 Act, the SEC is authorized to adopt rules and regulations creating special exemptions for securities offerings not exceeding $5 million in total value. Rule 504 and Rule 505 were adopted under this authority. In addition, the SEC adopted six other Rules under Regulation D.
Rule 504 creates an exemption from registration for securities offerings issued by non-reporting companies in an amount of less than $5 million in a 12-month period. Investment companies may not use this exemption. Under the Securities Acts, a non-reporting company is one that is not required to submit reports to the SEC pursuant to the 1934 Act.
Rule 505 created an exemption from registration for securities offerings by any issuer, except investment companies, of less than $5 million in a 12-month period to no more than 35 “non-accredited” investors (the number of accredited investors offered is unlimited). However, an issuer is disqualified from using this Rule if it or affiliates or their employees, agents, officers or directors have been subjects of certain administrative, civil or criminal actions. This last provision is referred to as the “bad actor” disqualification.
Rule 506  creates an exemption from registration for securities offerings by any issuer to an unlimited number of accredited investors plus an additional 35 “sophisticated” persons. Rule 506 is the most favored Rule because there is no limit to the amount that can be raised and because this federal exemption preempts state securities laws and regulations.
Rule 501 defines what constitutes an “accredited” investor for the purposes of the other rules. Under Rule 501 there are eight (8) categories of accredited investors, which are:
- Certain institutional investors, such as banks, savings & loans, registered broker dealers;
- Business development companies, such as investment companies or venture capital firms;
- Certain nonprofit or charitable organizations with total assets in excess of $5 million;
- Directors, officers and general partners of the issuer;
- Any “natural person” whose household net worth is more than $1,000,000 (excluding the value of the residence);
- Any “natural person” who had an individual income in excess of $200,000 in each of the two most recent years or joint income with a spouse in excess of $300,000;
- Any trust with assets in excess of $5 million where the purchase is directed by a sophisticated person who is an accredited investor; and
- Any entity in which all of the owners of the entity are accredited investors.
For securities offerings covered by the Rule 504 exemption, Regulation D does not require a disclosure-type document like a prospectus. If the securities are sold under Rule 505 or 506 to accredited investors, the type of information that must be furnished depends on the size of the offering and whether the issuer is subjected to the reporting requirements of the 1934 Act.
A non-reporting issuer is, nevertheless, required to:
(a) Provide the same kind of non-financial information as is required by the registration form under Section 5, including business history and operations and management and market risk data; and
(b) Provide, in the case of offerings of amounts up to $2 million, financial information including an audited issuer balance sheet within 120 days of the start of the offering. For offerings in sizes ranging from $2 to $7.5 million, the issuer must provide two-year audited income and balance sheet financial statements. For offerings in excess of $7.5 million, the issuer must provide the same information required under Form S-1, which is the required registration statement under Section 5, including two-year audited balance sheets and three-year audited income statements.
The J.O.B.S. Act and Regulation D
The Jumpstart Our Business Startups Act (the “JOBS Act”), adopted in 2012, was intended to facilitate the raising of investment capital by small businesses and startup ventures. The JOBS Act amended the Securities Act of 1933 in the area of exempt securities offerings. Title III of the JOBS Act, which is entitled “Crowdfunding,” permits greater use of private placements offerings for qualified small and new ventures to raise funds via online platforms. Accordingly, the SEC amended or adopted current Regulation D rules to deal with general solicitation of investors using online platforms
New Rule 506(c) permits general solicitation in Rule 506 offerings. The Supreme Court decision in Ralston Purina had approved private offerings to a limited number of offerees. These offerees, the Court believed, would be able to fend for themselves due to their sophistication or net worth that would permit them to get access to top advisors.
However, to make the JOBS Act work, issuers would use the Internet to access millions of potential offerees – thus, the issue is, how do you separate the qualified, accredited investors from the non-accredited investors?
The SEC published its new rules governing general solicitation on July 24, 2013. General solicitation is permitted, if:
– All purchasers of the securities meet the standards of accredited investors, either because they meet the requirements under existing Rule 501, or because the issuer reasonably believes they meet the requirements and
– The issuer must take reasonable steps to verify that all purchasers of the securities are accredited investors.
An issuer can take steps to reasonably verify that all investors are accredited by considering:
– Who is the purchaser, and what type of accredited investor category does he fall under based on his profile;
– What information the issuer has on the potential investor to establish that he is an accredited investor;
– The nature of the offering, including its size, how the purchaser was solicited, and the minimum investment amount required of the purchaser.
The SEC has stressed that flexibility is important. Gathering data on purchaser information is critical. If, after the offering, it is later discovered that large numbers of non-accredited investors were accepted, this could result in rescission of the entire offering amounts that were collected. It is also worthy to note that investors should be provided with as much information as possible, as the due diligence defense shield is applicable to private placement offerings as to public offerings discussed in module 3.
Thus, counsel’s role in investigating all the facts, data, documents, and files continues to be critical in private placement offerings, especially those offered via Internet-based platforms.
Strict compliance with Regulation D rules is central for legal counsel in assisting issuer clients with prospective private placement of securities. The upside rewards and downside risks for the client are equally risky, if not more so, when the private placement of securities is pursued, as opposed to via a registered offering under Section 5.
In our last module, we’ll look at state laws, the so called “blue sky” laws that affect and regulate corporate finance.
 15 U.S.C. Section 77(e);15 U.S.C. §77e(a)(1)
 15 U.S.C. §77(d)(a)(2), formerly Section 4(2), amended by the JOBS Act
 15 U.S.C. §77(c)(a)(2)
 See https://www.sifma.org/wp-content/uploads/2018/09/SIFMAs-State-of-the-Markets-2018.pdf
 15.U.S.C. §77(c)(a)(3)
 http://fred.stlouisfed.org/series/COMPOUT, March 31, 2019
 15 U.S.C. §77(c)(a)(5)(B)
 15 U.S.C. §77(d)(a)(1)
 15 U.S.C. Sections 77(c) and (d)
 15 U.S.C. Section 77(d)(a)(2)
 SEC v. Ralston Purina Co., 346 U.S. 119(1953)
 17 C.F.R. Section 230.500, Regulation D; https://www.upcounsel.com/regulation-d
 17 C.F.R. Section 230.500, Regulation D; https://www.ecfr.gov/cgi-bin/retrieveECFR?gp=&SID=8edfd12967d69c024485029d968ee737&r=SECTION&n=17y184.108.40.206.220.127.116.11
 Pub. L. 112-106, 15 U.S.C. 77(b)(a)
 Id or https://www.govinfo.gov/content/pkg/PLAW-112publ106/html/PLAW-112publ106.htm
 17 C.F.R. Section 240.12g
 See SEC Release No. 33-9415 available at https://www.sec.gov/rules/final/2013/33-9415.pdf