Start-up enterprises seeking to raise capital via a private placement offering are often confused as to which approach to take that best addresses SEC regulations that govern investor offerings. Many times, Issuers are presented with options by their legal counsel that recommend SEC Regulation D (Reg D) and/or Regulation S aka Reg S. For those seeking a primer in the distinction between Reg S and Reg D, Prospectus.com contributing analyst Asher Rothstein offers an easy-to-grasp explanation that distills the distinction between Reg S and Reg D.
In most cases, an American company that wishes to issue securities to investors must register them with the Securities and Exchange Commission (SEC). However, in some cases, companies can be exempt from registration under certain regulations. One such regulation is Regulation D (Reg D), which allows a company to issue securities without registering them with the SEC, as long as the business complies with every requirement of the regulation. One key aspect of Reg D is that the offering must be private, meaning that the issued securities cannot be offered to the public. As a result, there can be no advertising or marketing of the debt or equity securities. This aspect of the regulation is covered under Rule 506(b) which is a smaller section of Regulation D. The individuals who are approached as prospective investors can be residents of any country inside the US or outside. However, the method of approach cannot be public in any manner, and there can absolutely be no advertising domestically or internationally.
Interestingly, another aspect of Regulation D counters Rule 506(b) and allows the issuer of the securities to solicit and advertise publicly. Under this rule, the issuer can publicize their securities through television, radio, the internet, print, and in-person. This avenue of Reg D is known as Rule 506(c). Once again, the targeted investors may be citizens of any country, however, when the issuer is publicly soliciting them, they must make sure that the entirety of their audience are accredited investors.
Before any investor subscribes to an issuer of a private placement offering, there has to be verification. What this means is that the company must take steps to ensure all prospective investors are “accredited” before selling them any securities. If the company fails to conduct this verification, they will not be in compliance with Regulation D through Rule 506(c). If this is not done properly, it will lead to future complications with the SEC, as this problem cannot be solved at a later date. Verification must happen before any sale of securities takes place.
To sum it up, Regulation D Rule 506(c) is advantageous for Issuers of a private placement offering in that it allows issuers to publicly inform prospective investors about their securities, however, it also requires the process of timely, thorough verification of all investors. For this process, the issuer does not necessarily have to conduct verifications on their own. There are independent accredited investor verification services that perform these evaluations while still complying with every aspect of Rule 506(c). Interestingly, Rule 506(c) is a new addition to Regulation D, and it is for this fact that most issuers of private securities prefer to utilize Rule 506(b) in which they do not engage in public advertisements.
Regulation S is similar to Regulation D in that it provides exemption from registering private securities with the SEC. The main difference is that Regulation S is intended for offerings aimed exclusively at international investors. The status of an “international investor” is based more on geography rather than citizenship. For example, if an investor is physically based within the United States, that person is conserved a domestic investor, even if they are not a citizen of the country. Under Reg S, sales can only be made to non-US individuals. To further support this main tenet of the regulation, the second requirement states that there can be absolutely no solicitation of advertising inside the United States.
In many cases, securities law firms will construct offerings in a way that allows Issuers to claim Reg S and Reg D exemptions for all possible investors that are outside of the US. The reason behind this is so that if one exemption doesn’t pan out, there is a fail-safe. If, for example, there is no exemption to fall back on, the Issuer would face a scenario in which they conducted an offering that was not exempt and also not registered which would cause major complications.
When engaging in this two exemption strategies, one must be very careful to avoid certain complications that will arise. For example, if Rule 506(c) is the route taken under Regulation D (the newer avenue which allows advertising to the public), one has to remember that under Regulation S, public advertising in the US is not allowed. So, if the two-exemption strategy is taken, you may choose Rule 506(c) but you are still unable to publicly advertise because of Reg S.
In this age of technology and easily accessible information, it can be extremely hard to advertise a private placement offering publicly outside of the US without having individuals inside the US finding it. Although this may be difficult, it is still possible. Unfortunately, if this advertising is not done in a careful manner, and individuals in the US do access it, a private placement offering under Regulation S can be lost. If this were to happen, the private placement offering under rule 506(c) has to be very carefully followed. If not, there is risk of losing both offering exemptions with no fail-safe which would leave the offering unregistered and un-exempt, causing many complications and exposure to SEC enforcement. Securities issuers who claim both Regulation S and D exemptions target investors outside the United States. If said issuers also want to approach possible investors inside the US, they can engage in a companion offering that can be used to sell the same securities by only claiming Regulation D exemption, because Regulation S by nature cannot be used for individuals within the US.