Client Alert

SEC Proposes Revisions to Limited Offering Exemption Under Regulation D

December 14, 2007

In August 2007, the Securities and Exchange Commission ("SEC") proposed revisions to Regulation D.¹ The stated purpose of the proposal was to provide additional flexibility to issuers and to clarify and improve the application of the rule. Comments on the proposal were due October 9, 2007. Approximately 60 comment letters were filed expressing various views with respect to the proposal. The SEC has not yet set a time frame for consideration and final adoption of the rule. If adopted, the final rule could have significant implications for private offerings under Regulation D as well as for the sale of hedge fund and private equity fund interests to certain individual investors.

Background

Regulation D was originally adopted in 1982 to provide an exemption from registration under the Securities Act of 1933 (the "Securities Act") for certain types of offerings.² Rule 504 of Regulation D exempts issuers that are not subject to reporting under the Securities Exchange Act of 1934 in the offer and sale of up to $1,000,000 of securities in a twelve-month period. Rule 505 provides an exemption for offers of up to $5,000,000 of securities in a twelve-month period. Rule 506 exempts offers that are made to "accredited investors," and up to 35 non-accredited investors, with no dollar limit on the size of the offering. No general solicitation or advertising is currently allowed in connection with Regulation D offerings.

Summary of Proposed Revisions

The proposed revisions to Regulation D would:

• Add a new Rule 507 that would exempt offers and sales of securities to "large accredited investors" and permit limited advertising in connection with such offerings; 
• Amend the definition of "accredited investor" in Rule 501(a) by adding an alternative "investments-owned" standard, adding a mechanism to adjust the dollar-amount thresholds to reflect future inflation starting on July 1, 2012, and adding categories of entities to the list of permitted accredited investors; 
• Shorten the Regulation D integration safe harbor time frame from six months to ninety days; 
• Create uniform disqualification provisions for all Regulation D offerings; and 
• Establish a new category of accredited investor, i.e.,"accredited natural person," applicable to individuals who invest in certain private pooled investment vehicles in reliance on Rule 506.³

Proposed Exemption for Limited Offers and Sales to Large Accredited Investors

Proposed Rule 507 would create a new exemption from registration for offers and sales of securities to "large accredited investors." The new exemption would share many of the characteristics of the existing exemption provided by Rule 506 but would differ in several significant respects: 

• Large accredited investors would be defined to include entities and individuals with significantly higher dollar-amount thresholds than those for accredited investors under Rule 506; 
• Issuers would be allowed to engage in limited advertising as opposed to the total ban on solicitation and advertising imposed by Rule 506; 
• Issuers would be allowed to sell securities only to large accredited investors, unlike Rule 506 that allows issuers to sell securities to up to 35 non-accredited investors; and
• The proposed exemption would not be available to offers and sales by pooled investment vehicles (i.e., hedge funds and private equity funds) relying on an exemption under Section 3(c)(i) of the Investment Company Act of 1940.

Large Accredited Investor Standard

Under proposed Rule 507, an "accredited investor" could qualify as a "large accredited investor" if the following conditions are met:

• Entities would be required to have $10 million in investments; 
• Individuals would be required to have $2.5 million in investments or have annual income of $400,000 (or $600,000 with one’s spouse); and 
• Entities that are not subject to dollar-amount thresholds to qualify as accredited investors, generally government-regulated entities, would also not be subject to dollar-amount thresholds to qualify as large accredited investors.

As noted above, the dollar thresholds would be adjusted for inflation every five years beginning on July 1, 2012.

Limited Advertising Permitted

Under proposed Rule 507, issuers would be permitted to publish a limited announcement of an offering. Such advertisement must prominently state that sales will be made only to large accredited investors, that no money or other consideration is being solicited or will be accepted through the announcement, and that the securities have not been registered with or approved by the SEC and are being offered and sold pursuant to an exemption from registration. At the issuer’s option, the announcement also could contain the following additional information:

• The name and address of the issuer; 
• A brief description of the business of the issuer in 25 or fewer words; 
• The name, type, number, price and aggregate amount of securities being offered and a brief description of the securities; 
• A description of what large accredited investor means; 
• Any suitability standards and minimum investment requirements for prospective purchasers in the offering; and 
• The name, postal or email address, and telephone number of a person to contact for additional information.

Publication of an announcement under Rule 507 would be limited to written form as opposed to "written communications" which is defined more broadly in Rule 405 to include a radio or television broadcast.

Proposed Revisions to Definition of "Accredited Investor"

The current definition of "accredited investor" can be found in Rule 501(a) of Regulation D. Revisions proposed by the SEC would also affect Rules 504 through 506 and, to the extent that the standards to qualify as a "large accredited investor" are based on the standards to qualify as an "accredited investor," Rule 507. The SEC's proposed revisions would:

• Add an alternative "investments-owned" standard to Rule 501(a): 
  • Alternative Test for Entities -- $5 million in investments owned; 
  • Alternative Test for Individuals -- $750,000 in investments owned excluding personal residence and places of business; 
• Define the term "joint investments" to mean only 50% of investments owned jointly with an investor's spouse; 
• Establish a mechanism to adjust the dollar thresholds for inflation every five years beginning on July 1, 2012; and 
• Add several categories of permitted entities to the list of accredited and large accredited investors.

Proposed Definition of "Accredited Natural Person"

In its Private Pooled Investment Vehicle Release⁴, the SEC proposed a revision to Regulation D to establish a new category of accredited investor, i.e., "accredited natural person." Under the proposal, individuals would need to qualify as "accredited natural persons" in order to invest in certain private pooled investment vehicles (i.e., hedge funds and private equity funds) sold in reliance on Rule 506 and relying on the exemption in Section 3(c)(1) under the Investment Company Act. In order to meet this proposed new standard, the individual investor would have to meet the accredited investor test as well as a new test for $2.5 million in investments. The definition of "investments" would track the proposals for the new "investments-owned" standard for accredited investors described above. Over 600 comment letters were filed with respect to this proposal, mostly in opposition, yet the SEC determined to re-propose these changes in the current release.

Conclusion

If adopted, the proposed rules could have significant implications on private offerings under Regulation D. Proposed Rule 507 offerings to "large accredited investors" could increase flexibility in the conduct of exempt offerings by allowing limited advertising in connection with those offerings. Decreasing the integration safe harbor to 90 days could allow issuers more frequent access to the markets. On the other hand, increasing the qualification requirements for individual investors in hedge funds and private equity funds could make it more difficult for certain investors to invest in those securities. As noted above, the SEC has not yet set a date for a final decision on this proposal.⁵

^{1 Securities Act Release No. 33-8828 (Aug. 3, 2007); 72 F.R. 45116 (Aug. 10, 2007).
2 17 C.F.R. 230.501 through 230.508.
3 Proposed Rules 216 and 509 under the Securities Act. See Securities Act Release No. 33-8766 (Dec. 27, 2006); 72 F.R. 400 (Jan. 4, 2007). ("Private Pooled Investment Vehicle Release"). As noted in an earlier client alert, a proposed rule prohibiting fraud in connection with pooled investment vehicles has been adopted. See Chadbourne Client Alert dated August 8, 2007.
4 Supra Note 3.
5 Ryan Houseal, an associate at Chadbourne & Parke LLP, contributed to this alert.}