Serie – Part 2: Accessing the US Capital Markets, Foreign Issuers Get This

 Last time, we reviewed the basic principles underlining regulatory compliance for foreign issuers dealing with US investors in attempts to raise capital. Here below, we follow with private fundraisings requirements which are in a class of their own as they apply to those privately held entities and what some may consider private relationships. Please read below:

Private Fundraisings in the United States

Issuer Private Placements pursuant to Section 4(a)(2) and Regulation D
As noted above, Section 5 of the Securities Act prohibits the offer and sale of a security into the United States absent its registration with the SEC, unless both the offer and sale are made in a transaction that is exempt from, or not subject to, such registration requirements. Relatively few FPIs attempt to register their offerings with the SEC; the preferred alternative being to utilize private placement exemptions, the most commonly used being:

• Section 4(a)(2) of the Securities Act (formerly Section 4(2) before its re-designation by the JOBS Act); and

• Regulation D, which supplements Section 4(a)(2) by setting out specific requirements for how to conduct private placements.

Section 4(a)(2)
Section 4(a)(2) of the Securities Act exempts from registration offers and sales by the issuer that do not involve a public offering or distribution (hence, ‘private placement’). While the term public offering has never been defined formally by the SEC, several factors have emerged from case law and SEC rulings that set out when transactions are not deemed to involve a public offering for purposes of Section 4(a)(2):

• Sophistication of the investors: Offerees must be sophisticated and have knowledge and experience of financial and business matters to evaluate the risks and merits of offerings that are not subject to the same process as deals that are registered with the SEC. Sophisticated investors would include “accredited investors” and “qualified institutional buyers” (as defined in Rule 501 and Rule 144A, respectively).

• Limited number of investors. Although there is no express requirement to limit the number of investors, issuers generally try to control the number of offerees and investors in order to avoid selling to unsophisticated investor or raise the potential violation of the following restriction.

• Prohibition on general solicitation and general advertising. Neither the issuer (nor anyone acting on its behalf) can offer or sell securities by means of any form of “general solicitation” or “general advertising”. General solicitation and general advertising is very broad and would likely include posting information on a website. As discussed below, the JOBS Act did not amend this prohibition as it relates to Section 4(a)(2).

• Information requirement. Although Section 4(a)(2) does not require any specific information to be furnished to investors, potential investors may receive a private placement memorandum, which is a disclosure document prepared by the issuer that provides investors with basic information about the issuer and the securities being offered.

• Transfer restrictions on restricted securities. Buyers are generally required to buy larger blocks of unregistered securities that carry transfer restrictions to increase the likelihood these restricted securities are bought by suitably sophisticated investors.

• Investment intent. Investors must buy the unregistered securities for their own account, without a view to resell or distribute them to others immediately.]

Regulation D (Rule 504, Rule 505, Rule 506(b) and Rule 506(c))
Rule 504, Rule 505, Rule 506(b) and Rule 506(c) of Regulation D are private placement exemptions that provide a few different options for issuers seeking to raise capital from U.S. investors.  Each exemption contains certain requirements and limitations that may make them more or less attractive depending on the potential deal size, the issuer and the potential investor base.

Prior to the JOBS Act and the creation of Rule 506(c), offers of securities to U.S. investors pursuant to any rule under Regulation D could not be made by means of any form of “general solicitation” or “general advertising”.  As noted above, these terms include a very wide range of marketing activities and would likely include posting the offer of securities on a website which is available to the public or which does not have active screening or investor verification procedures, as discussed below.  As a result, marketing activities in the United States in relation to private placements pursuant to Rules 504 through Rule 506 typically have been directed at a restricted number of sophisticated investors.

Although Rule 504, Rule 505 and Rule 506(b) still prohibit general solicitation and general advertising, issuers may publicize their offers more widely if they are making an offer pursuant to Rule 506(c). This has the potential to open up the internet to so called “private placements” by issuers, both U.S. issuers and FPIs, subject to the other restrictions set out in Rule 506(c) discussed below.

The Differences between Rules 504, 505, 506(b) and 506(c)
Prior to the creation of Rule 506(c), the fundamental differences between Rules 504 through 506 were the amount of money that could be raised and the type of investors that could be targeted.  Rule 504 caps the total amount that can be raised at $1 million per year and does not limit the number of investors or the sophistication of those investors.  On the other end of the spectrum, Rule 506(b) and Rule 506(c) have no limit to the amount of money that can be raised, though Rule 506(b) only allows for 35 non-accredited investors and Rule 506(c) allows for zero non-accredited investors.

Note again that each exemption in Regulation D, except for Rule 506(c) effectively prohibits general solicitation and general advertising. Although Rule 504 includes exceptions to this prohibition, issuers that avail themselves of these exceptions must register the securities in at least one state. On a related point, note that securities offered and sold pursuant to Rule 506 are considered to be “covered securities”, while securities issued pursuant to Rules 504 and 505 are not.  U.S. state securities laws (or “Blue Sky Laws”) apply to the offer of sale of securities to investors in the relevant state, unless the securities are “covered securities” and therefore exempted by federal securities laws. Blue Sky Laws can be very different from state to state and compliance with these laws can be expensive and complicated.

The table below sets out some of the basic information for Rule 504, Rule 505, Rule 506(b) and Rule 506(c):

Rule 504, Rule 505 and Rule 506(b) are each complicated, but we will not discuss them much further here.  Rule 506(b), in particular, can be very useful to FPIs and will be touched on a bit in the third part of this serie. The focus will be Rule 506(c), however, as this rule is new to the market and may represent a real opportunity for FPIs. Please follow me next month to continue to read on this new one and the connections to the prior regulation.