July 1992
In an effort to make it easier for small businesses to raise money, the Securities and Exchange Commission is revising several regulations governing commonly used exemptions from securities registration. Proposed changes to Regulation A and to Rule 504 under Regulation D will increase the amounts that can be raised, simplify disclosure requirements and, to some extent, liberalize restrictions on advertising some types of unregistered offerings of securities.
Under the federal securities laws an issuer must either register stock with the SEC before offering it to the public, or must satisfy requirements for an exemption from registration. Given the expense of the registration process (which can easily cost $200,000), most small companies raising money try to do so in exempt offerings.
One exemption is Rule 504 under Regulation D. Rule 504 has the advantage of not prescribing the form of the offering literature: while the issuer must give investors enough information to make an informed investment decision, the scope and details of that information are left to the discretion of the issuer.
Unfortunately, in its present form Rule 504 has several drawbacks. It currently provides that, if the stock has not been registered under state securities law , the federal exemption is available only if (i) the dollar amount that can be raised is no more than $500,000, (ii) the issuer does not advertise the sale of the stock and (iii) the buyer’s ability to transfer the stock is restricted. In most cases, this effectively limits the availability of a Rule 504 offering to a private placement of no more than $500,000 of stock. It also means that only those who are able to hold the stock for long periods of time are likely to be interested in investing.
The proposed changes to Rule 504 would make the federal exemption from registration independent of state registration. Regardless of registration under state law, the federal exemption would be available for offerings of up to $1,000,000, even if the issuer advertises the sale, and buyers would be permitted to resell the stock freely.
In contrast to Rule 504, Regulation A is similar to a registered public offering in that a formal offering document, and filing with the SEC, are required. The SEC is proposing revisions to the form of offering document to make it more “user friendly.” A major portion of the current form would be replaced with a question-and-answer form (Form U-7) recently developed to simplify disclosure requirements for issuers and provide investors with an offering document that is easily understood. (See the discussion of “SCOR” offerings and Form U-7 in our October 1991 issue.) In addition, the new Regulation A dollar limit would be $5,000,000 instead of the current $1,500,000.
TLB Comment: These proposals represent a critical step toward making capital available to small companies. However, they only address half of the problem. Securities sales are regulated at both the federal and the state levels. While the SEC’s proposals would make compliance with federal law easier, they do not address state “blue sky” laws. These laws vary from state to state, and an issuer must comply with the laws of each state in which it offers stock. Frequently, availability of an exemption from state registration is dependent upon complex and arcane rules, and upon compliance with unpublished policies of state securities administrators. We hope the states will bring their respective blue sky laws into line with these proposed federal changes; once they do, the SEC’s proposals will indeed reduce the costs of offerings, increase the ability of small issuers to identify buyers and enhance the ability of small companies to raise money.