[Federal Register Volume 64, Number 44 (Monday, March 8, 1999)]
[Rules and Regulations]
[Pages 11090-11094]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-5295]
[[Page 11089]]
_______________________________________________________________________
Part II
Securities and Exchange Commission
_______________________________________________________________________
17 CFR Part 230, et al.
Revision of Rule 504 of Regulation D, the ``Seed Capital'' Exemption;
Rule 701--Exempt Offerings Pursuant to Compensatory Arrangements;
Registration of Securities on Form S-8; Final Rules
Registration of Securities on Form S-8; Publication or Submission of
Quotations Without Specified Information; Proposed Rules
Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Rules
and Regulations
[[Page 11090]]
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 230
[Release No. 33-7644; S7-14-98]
RIN 3235-AH35
Revision of Rule 504 of Regulation D, the ``Seed Capital''
Exemption
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``we'' or
``Commission'') is adopting amendments to Rule 504 of Regulation D,
which provides an exemption from Securities Act registration for
securities offerings of non-reporting companies that do not exceed an
aggregate annual amount of $1 million. Recent fraudulent secondary
transactions in the over-the-counter markets of ``microcap'' companies
have involved freely tradable securities issued in Rule 504 offerings.
To curb these abuses, we are modifying Rule 504 to limit the
circumstances where general solicitation is permitted and ``freely
tradable'' securities may be issued in reliance on the rule to
transactions registered under state law requiring public filing and
delivery of a disclosure document to investors before sale, or exempted
under state law permitting general solicitation and advertising so long
as sales are made only to accredited investors. Since most transactions
under Rule 504 are private ones, they will continue to be permissible
under the exemption, but general solicitation and advertising will not
be permitted and the securities will be ``restricted.''
EFFECTIVE DATE: April 7, 1999.
FOR FURTHER INFORMATION CONTACT: Richard K. Wulff or Barbara C. Jacobs
(202-942-2950), Office of Small Business, Division of Corporation
Finance, Securities and Exchange Commission, 450 Fifth Street, NW,
Washington, DC 20549.
SUPPLEMENTARY INFORMATION:
I. Executive Summary and Background
Congress has passed significant legislation to aid small businesses
in raising capital in the private and public securities markets over
the years. The Small Business Investment Incentive Act of 1980, for
example, was designed to reduce the regulatory restraints on small
business capital formation.\1\ In response to that Act, in 1982, we
adopted Regulation D \2\ under the Securities Act of 1933 (``Securities
Act'').\3\ Regulation D is an exemption from Securities Act
registration that was designed to:
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\1\ Pub. L. No. 96-477, 944 Stat. 2275. That Act amended the
Securities Act by adding Section 4(6) [15 U.S.C. 77(d)(6)], which
among other matters, exempts from registration offers or sales of
securities in the aggregate amount of $5 million or less if solely
made to ``accredited investors''.
\2\ 17 CFR 230.501 et seq. See Release No. 33-6389 (March 8,
1982) [47 FR 11251].
\3\ 15 U.S.C. 77a et seq.
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Simplify existing rules and regulations;
Eliminate any unnecessary restrictions that those rules
and regulations placed on issuers, particularly small businesses; and
Achieve uniformity between state and federal exemptions in
order to facilitate capital formation consistent with the protection of
investors.\4\
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\4\ See Release No. 33-6389 at Section II.A.
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Regulation D provides exemptions from Securities Act registration
for securities offerings under three separate rules: Rules 504, 505 and
506.\5\ Rule 504 is the limited offering exemption designed to aid
small businesses raising ``seed capital.'' Currently, Rule 504 permits
a non-reporting issuer \6\ to offer and sell securities to an unlimited
number of persons without regard to their sophistication or experience
and without delivery of any specified information in a public
offering.\7\ General solicitation and general advertising are permitted
for all Rule 504 offerings. The aggregate offering price of this
exemption is limited to $1 million in any 12-month period; and certain
other offerings must be aggregated with the Rule 504 offering in
determining the available sales amount.\8\ Securities sold under this
exemption may be resold freely by non-affiliates of the issuer \9\ who
are not otherwise acting as an underwriter.\10\
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\5\ Rules 504 and 505 are dedicated to the needs of small
issuers; they are based on our authority under Section 3(b) of the
Securities Act [15 U.S.C. 77(b)], which permits us to create
exemptions where the aggregate amount of the offering does not
exceed $5 million. In 1996, Section 28 was added to the Securities
Act [15 U.S.C. 78bb], which gives us broad general exemptive
authority without dollar limit. In a companion release, we are
adopting amendments to Rule 701 of the Securities Act [17 CFR
230.701] pursuant to this new authority. See Release No. 33-7645.
Rule 505 is designed to help small businesses because it permits
sales to a small number of nonaccredited, unsophisticated investors.
Rule 506 is our non-exclusive safe harbor rule adopted under the
``non-public'' offering exemption of Section 4(2) of the Securities
Act [15 U.S.C. 77d(2)]. It permits sales only to accredited
investors and a limited number of sophisticated investors.
\6\ A non-reporting issuer is an issuer that is not required to
file reports with the Commission under Section 13 or 15(d) of the
Securities Exchange Act of 1934 [15 U.S.C. 78a et seq.] (``Exchange
Act''). We recently approved a proposed rule amendment to Rule 6530
of the National Association of Securities Dealers, Inc. (``NASD'')
to limit quotations on the OTC Bulletin Board (``OTCBB'') to the
securities of issuers that make current filings under Section 13 or
15(d) or other applicable regulatory authority, among other matters.
See Release No. 34-40878 (January 4, 1999) [64 FR 1255]. As such,
once an OTCBB issuer becomes subject to our reporting requirements,
it would be ineligible to use Rule 504.
In our recent Securities Act Reform proposals, we solicited
comment on whether a reporting company should be able to rely on
Rule 504 for the issuance of securities underlying convertible
securities and warrants that it had previously offered in compliance
with Rule 504 when it was not a reporting company. See Release No.
33-7606 (November 3, 1998) [63 FR 67174].
\7\ Other issuers that are ineligible to use Rule 504 include
investment companies or development stage companies that either have
no specific business plan or purpose or have indicated that the
business plan is to engage in a merger or acquisition with an
unidentified company or companies, or other entity or person. See
Rule 504(a) of Regulation D.
As with all Regulation D offerings, we require a Form D, a
simple six-page notice, to be filed with us no later than 15 days
after the first sale in the Rule 504 offering. See Rule 503 of
Regulation D [17 CFR 230.503]. Filing a Form D is not, however a
condition to the exemption.
\8\ Rule 504 offerings are aggregated for this purpose with all
other offerings exempt under Section 3(b) (e.g., Rule 504 or Rule
505 offerings) and all offerings made in violation of Section 5(a)
of the Securities Act [15 U.S.C. 77e(a)].
\9\ See interpretive letter to Mr. E.H. Hawkins (June 26, 1997),
setting forth the views of the Division of Corporation Finance that
affiliates who receive securities in a Rule 504 offering are subject
to resale limitations.
\10\ See fn. 17 and 18, below.
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While Regulation D offerings are exempt from federal securities
registration requirements, currently these offerings must be registered
in each state in which they are offered unless a state exemption is
available.\11\ The vast majority of states require registration of
public Rule 504 offerings.\12\ In adopting Rule 504, we placed
substantial reliance upon state securities laws because the size and
local nature of these small offerings did not appear to warrant
imposing extensive federal regulation. These offerings continue,
however, to be subject to federal antifraud and other civil liability
provisions.
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\11\ See, e.g., the Uniform Limited Offering Exemption
(``ULOE'') developed by the North American Securities Administrators
Association, Inc. (``NASAA''), which was designed to be a
coordinating state exemption with Rule 505 of Regulation D, and
optionally Rule 506. Rule 504 is not a part of ULOE.
NASAA is an association of securities commissioners from each of
the 50 states, the District of Columbia, Puerto Rico, Mexico and
several provinces of Canada.
\12\ New York and the District of Columbia do not require
registration of Rule 504 offerings.
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Unfortunately, there have been recent disturbing developments in
the secondary markets \13\ for some securities
[[Page 11091]]
initially issued under Rule 504,\14\ and to a lesser degree, in the
initial Rule 504 issuances themselves.\15\ These offerings generally
involved the securities of ``microcap'' companies, i.e., those
characterized by thin capitalization, low share prices, limited public
information and little or no analyst coverage. Recent market
innovations and technological changes, most notably, the Internet, have
created the possibility of nation-wide Rule 504 offerings for
securities of non-reporting companies that were once thought to be sold
locally.
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\13\ These secondary markets include the OTCBB operated by the
NASD or the pink sheets published by the National Quotation Bureau,
Inc.
\14\ See, e.g., SEC v. Szur, et al., Lit. No. 15595, S.D.N.Y.,
December 18, 1997; SEC v. Badger, et al. Lit. No. 15595, S.D.N.Y.,
December 18, 1997; SEC v. Scudiero, et al., Lit. No. 15595,
S.D.N.Y., December 18, 1997; SEC v. Ruge, et al., Lit. No. 15595,
S.D.N.Y., December 18, 1997; and SEC v. Pignatiello, et al., Lit.
No. 15595, S.D.N.Y., December 18, 1997. In these cases, we filed
five civil injunctive actions charging fifty-eight defendants with
manipulation of the over-the-counter markets for ``microcap''
securities. The five actions were the result of an undercover
investigation into illegal practices in these markets conducted by
the United States Attorney's Office for the Southern District of New
York and the Federal Bureau of Investigation, with assistance from
the NASD and us.
See also Schroeder, ``Penny Stock Fraud is Again on a
Resurgence, Bolstered by Loopholes and New Technology, Wall St. J.,
September 4, 1997 at 12.
\15\ See, e.g., SEC v. Millennium Software Solutions, Inc. and
Mark Shkolir, Lit. No. 15603, S.D.N.Y., December 23, 1997 and SEC v.
Spacedev, Inc. and James W. Benson, Securities Act Rel. No. 7561,
August 6, 1998.
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In some cases, Rule 504 has been used in fraudulent schemes to make
prearranged ``sales'' of securities under the rule to nominees in
states that do not have registration or prospectus delivery
requirements. As a part of this arrangement, these securities are then
placed with broker-dealers who use cold-calling techniques to sell the
securities at ever-increasing prices to unknowing investors. When their
inventory of shares is exhausted, these firms permit the artificial
market demand created to collapse, and investors lose much, if not all,
of their investment. This scheme is sometimes colloquially referred to
as ``pump and dump.''
Regulation D is only available for offers and sales by an issuer of
securities to initial purchasers; it is not available to any affiliate
of the issuer or to any person for resales of the securities.\16\ Thus,
where a purchaser of Rule 504 securities wishes to sell these
securities, he or she must either register the transaction or have an
exemption for the transaction. Those who purchase such securities with
a view to their distribution are acting as ``underwriters'' \17\ and
thus their sales of the securities are not exempt from
registration.\18\ In these circumstances, these persons could be
charged with violating Section 5 of the Securities Act.\19\ In
addition, they could be charged with violating the antifraud provisions
of the Securities Act and the Exchange Act for any material
misrepresentations made in the Rule 504 offering.\20\
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\16\ See Preliminary Note 4 to Regulation D.
\17\ The term ``underwriter'' is defined in Section 2(a)(11) of
the Securities Act [15 U.S.C. 77(b)(11)] to include ``any person who
has purchased from an issuer with a view to, or offers or sells for
an issuer in connection with, the distribution of any security, or
participates or has a direct or indirect participation in any such
undertaking, or participates or has a participation in the direct or
indirect underwriting of any such undertaking. * * *
\18\ In particular, the ``resale'' exemption of Section 4(1) of
the Securities Act [15 U.S.C. 77d(1)] is unavailable since the
exemption is available to ``any person other than an issuer,
underwriter or dealer.'' In this case, the purchasers are acting as
underwriters, as explained above. The dealer exemption of Section
4(3) of the Securities Act [15 U.S.C. 77d(3)] also is unavailable
where the person relying upon the exemption acts as an
``underwriter.''
See also Note 6 to Regulation D, which provides that Regulation
D is not available to any issuer for any transaction or chain of
transactions that, although in technical compliance with the rules,
is part of a plan or scheme to evade the registration provisions of
the Securities Act. In such cases, registration is required.
\19\ 15 U.S.C. 77e.
\20\ Section 17 of the Securities Act [15 U.S.C. 77q(a)],
Section 10(b) of the Exchange Act [15 U.S.C. 78j(b)] and Rule 10b-5
thereunder [17 CFR 240.10b-5].
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On May 21, 1998, we proposed amendments to Rule 504 to eliminate
the freely tradable nature of the securities issued under the
exemption.\21\ If we adopted that proposal, these securities could be
resold only:
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\21\ Release No. 33-7541 (May 21, 1998) [63 FR 29168] (``Rule
504 Proposing Release''). The Commission received 33 letters of
comment. The comment letters are available for inspection and
copying in the Commission's Public Reference Room in File No. S7-14-
98. Comments that were submitted electronically are available on the
Commission's website (www.sec.gov).
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After the one-year holding period of Rule 144\22\;
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\22\ 17 CFR 230.144.
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Through registration; or
Through another exemption (such as Regulation A\23\), if
available.
\23\ 17 CFR 230.251 et seq.
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By making all securities issued in a Rule 504 transaction restricted,
we thought that unscrupulous persons would be less likely to use the
rule as the source of freely tradable securities they need to
facilitate their fraudulent transactions.
In the Rule 504 Proposing Release, we also solicited comment on an
alternative to revise Rule 504 so it would be substantially similar to
its pre-1992 format, permitting public offerings only where the issuer
complies with state registration processes that require the preparation
and delivery of a disclosure document to investors before sale of the
securities. We also solicited comment on the appropriate treatment for
offerings made under certain state exemptions, such as the one recently
developed for sales to accredited investors.\24\
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\24\ State exemptions of this nature include those based upon
the ``Model Accredited Investor Exemption,'' which was adopted by
NASAA in 1997. CCH NASAA Reporter Para.361. Generally, the rule
exempts offers and sales of securities from state registration
requirements, if among other matters, the securities are sold only
to persons who are, or are reasonably believed to be, ``accredited
investors'' as defined in Rule 501(a) of Regulation D [17 CFR
230.501(a)]. The model restricts transfer of the securities for 12
months after issuance except to other accredited investors or if
registered. Written solicitations under that provision are generally
limited to a type of ``tombstone'' ad.
As of December 31, 1998, 29 states and the Commonwealth of
Puerto Rico have an accredited investor exemption permitting some
form of general solicitation and two states had adopted specific
accredited investor exemptions to work with the U.S. Small Business
Administration's Angel Capital Electronic Network (ACE-Net). Of
these, 15 states have adopted NASAA's Model Accredited Investor
Exemption through statute, regulation or executive order. The
remaining 14 states either have accredited investor exemptions pre-
dating the Model Exemption or have adopted variations of the Model
Exemption. Of the 19 states that do not have an accredited investor
exemption permitting general solicitation, seven have statutory or
regulatory language pending to adopt such an exemption.
ACE-Net is an Internet-based, securities listing service where
small, growing companies can list their stock offerings to
accredited investors. It is a public/private partnership between the
SBA and 38 non-profit, university-and state-based entities around
the country. See Angel Capital Electronic Network (pub. avail.
October 25, 1996).
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For the reasons discussed below, we are again conditioning the
availability of Rule 504 for public offerings on the extent of state
regulation over those offerings by making the exemption substantially
similar to its pre-1992 format.\25\ We believe that this alternative is
an effective way to combat the abuses we have described and at the same
time preserve the ability of legitimate small businesses to raise
capital. This approach is more narrowly targeted to the abuses we have
observed than simply restricting all securities issued in a Rule 504
transaction. As amended, the rule establishes the general principle
that securities issued under the exemption, just like the other
Regulation D exemptions, will be restricted, and prohibits general
solicitation and general advertising, unless the specified conditions
[[Page 11092]]
permitting a public offering are met. These conditions are:
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\25\ Unlike the rule as amended today, the pre-1992 format of
Rule 504 did not include a provision for state law exemptions for
sales made to accredited investors or any requirement for publicly
filing the disclosure document that is delivered to investors
although this has long been a standard feature of state registration
provisions. It also required issuers in private Rule 504 offerings
to advise purchasers of the resale limitations on the securities a
reasonable period of time before sale.
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The transactions are registered under a state law
requiring public filing and delivery of a disclosure document before
sale. For sales to occur in a state without this sort of provision, the
transactions must be registered in another state with such a provision
and the disclosure document filed in that state must be delivered to
all purchasers before sale in both states; or
The securities are issued under a state law exemption that
permits general solicitation and general advertising so long as sales
are made only to ``accredited investors'' as that term is defined in
Regulation D.\26\
\26\ See Rule 501(a) of Regulation D.
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Investor protection concerns require that this action be taken to curb
misuse of this exemption in the markets for ``microcap'' companies.
Requiring issuers to go through state registration and deliver
disclosure documents to investors in order to issue freely tradable
securities in Rule 504 transactions provides information for
prospective investors to make more informed investment decisions. These
amendments are part of our comprehensive agenda to deter registration
and trading abuses, particularly by ``microcap'' issuers. We have
developed a four-pronged approach to deter ``microcap'' fraud:
enforcement, investor education, compliance examinations, and
regulation.\27\
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\27\ We are issuing four companion releases today. See Release
No. 33-7646, which adopts revisions to Form S-8, the short-form
registration statement for issuing securities to employees,
consultants and advisors as compensation, in order to curb abusive
situations and Release No. 33-7647, which contains additional
proposals to Form S-8 to further reduce abuse of the form. See
Release No. 34-41110, which reproposes amendments to Exchange Act
Rule 15c2-11 [17 CFR 240.15c2-11] to require the first broker-dealer
that publishes any quotation for a covered security to review
information about the issuer and thereafter other broker-dealers to
review information about the issuer when they first publish or
resume publishing a priced quotation for a covered security. See
also Release No. 33-7645, which adopts amendments to Form 701, the
exemption for non-reporting companies to issue securities to
employees, consultants and advisors.
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We believe the amendments to Rule 504 adopted today will deter the
abuses we have seen, while not impeding legitimate ``seed capital''
offerings. We will monitor the use of the rule, as revised, and also
contact the state regulatory authorities regarding their experience
with these offerings. If it appears that Rule 504 is still being
misused, we will consider adding stronger measures, such as requiring
an after-market information delivery requirement \28\ or
disqualification provisions.\29\ With respect to the accredited
investor aspect of the revised rule, we will work with the states to
assess its use. If the new regulatory scheme is being misused,
particularly in states that do not impose transfer restrictions on the
resale of the securities by accredited investors, we will explore with
these states the viability of imposing such restrictions under their
provisions. Failing that, we would consider making the securities
``restricted'' as defined in Rule 144.
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\28\ See Section 4(3) of the Securities Act [15 U.S.C. 77d(3)],
Securities Act Rule 174 [17 CFR 230.174] and Rule 251(d)(2)(ii) of
Regulation A [17 CFR 230.251(d)(2)(ii)].
\29\ See Rule 505(b)(2)(iii) of Regulation D [17 CFR
230.505(b)(2)(iii)] or Rule 262 of Regulation A [17 CFR 230.262].
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II. Amendments to Rule 504
Before 1992, Rule 504 exempted both public and private offerings.
It exempted public offerings if sales did not exceed $1 million \30\ in
a 12-month period and if the offering was registered with one or more
states that required the preparation and delivery of a disclosure
document to investors before sale.\31\ Private offerings, in which
general solicitation and general advertising were prohibited, were
exempt if sales did not exceed $500,000. State registration was not a
condition to the exemption in the private context.
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\30\ As originally adopted in 1982, the exemption was subject to
a $500,000 limitation. In 1988, the ceiling for public offerings was
increased to $1 million. See Release No. 33-6758 (March 3, 1988) [53
FR 7866].
\31\ For example, Form U-7 (also referred to as ULOR, uniform
limited offering registration, or SCOR, small corporate offering
registration) was developed by NASAA to be a special registration
format for companies registering securities under state securities
laws when relying upon the federal Rule 504 exemption. See Harris,
Keller, Stakias & Liles, Financing the ``American Dream.''
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In July 1992, we adopted revisions to our rules and forms to
facilitate capital raising by small businesses by reducing the
compliance burdens placed on those companies by the federal securities
laws.\32\ The amendments eliminated all restrictions on the manner of
offering and on resales under Rule 504. As a result, a non-reporting
company could offer up to $1 million of securities in a 12-month period
and be subject only to the antifraud provisions of the federal
securities laws. General solicitation and general advertising were
permitted for all Rule 504 offerings. Further, securities sold under
Rule 504 were not ``restricted'' securities and thus were available for
immediate resale by non-affiliates of the issuer, as long as they were
not otherwise ``underwriters'' \33\ of the offering.\34\
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\32\ See Release No. 33-6949 (July 30, 1992) [57 FR 36442]. On
April 28, l993, we adopted additional revisions to further
facilitate financings by small business issuers. See Release No. 33-
6996 (April 28, 1993) [58 FR 26509].
\33\ Section 2(a)(11) of the Securities Act [15 U.S.C.
77b(a)(11)].
\34\ Regulation D exemptions are available only to the issuer of
the securities. None of these exemptions can be used by any other
person. See Preliminary Note 4 to Regulation D.
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In the Rule 504 Proposing Release, we proposed that all securities
issued in a Rule 504 transaction would be ``restricted'' from resale
for a one-year period after issuance. This proposal directly addressed
the abuses we witnessed in the secondary markets. Almost all commenters
objected to this approach, since it would require issuers to offer a
significant liquidity discount in all Rule 504 issuances, even fully
state registered ones, causing a significant reduction in the amounts
of capital they could raise. While acknowledging that this approach
would have some impact upon the targeted problem in the secondary
market, commenters, including NASAA, believed that our alternative
approach, which was to reinstitute the rule largely as it had been in
effect for a number of years before 1992, would be equally, if not
more, effective since if an issuer goes through state registration and
must deliver a disclosure document to prospective investors, sufficient
information ought to be available in the markets to permit investors to
make more informed investment decisions and thus deter manipulation of
Rule 504 securities. They also noted that this approach would not
unduly penalize small businesses, since they would have some avenue
open to them to issue freely transferable securities.
The amendments we adopt today implement the alternative narrower
reform. By returning the Rule 504 exemption largely to its pre-1992
framework, we intend to deter ``microcap'' fraud. We believe that the
vast majority of current Rule 504 offerings are private. Private
offerings under Rule 504 will be permitted for up to $1 million in a
12-month period, under the same terms and conditions, except for the
specific disclosure requirements,\35\ as offerings under Rules 505 and
506. Securities in these offerings will be restricted, and these
offerings may no longer involve general solicitation and advertising.
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\35\ Rule 502(b)(1) of Regulation D [17 CFR 230.501(b)(1)].
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On the other hand, the rule as revised leaves avenues open for
issuers to make less limited offerings under Rule 504. By focusing on
state registration, review and disclosure requirements, we are still
[[Page 11093]]
permitting legitimate small issuers to access the capital markets
without having to sell restricted securities. In adopting this reform,
we note that the state registration and review system is generally
comprehensive. As of the effective date of these amendments, an issuer
will only be able to issue unrestricted or freely tradable securities
in a Rule 504 offering and engage in general solicitation or general
advertising in two circumstances:
If it registers the offering under a state law that
requires the public filing \36\ and delivery of a disclosure document
to investors before sale; \37\ or
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\36\ The disclosure document must be publicly available at the
state level. This document must provide substantive disclosure to
investors, including the business and financial condition of the
issuer (including financial statements), the risks of the offering,
a description of the securities, and the plan of distribution. For
example, the issuer could provide the information required in a Form
U-7, as outlined in n.37, to satisfy this requirement.
\37\ If any state that the issuer intends to make sales in does
not provide for the registration or the public filing or delivery of
a disclosure document to investors before sale, then in order to be
able to issue freely tradable securities and to engage in public
solicitation or public advertising, the issuer must register in at
least one state with such a procedure. The disclosure document must
be delivered before sale to all purchasers, including purchasers in
the states that have no registration and delivery procedure. The
process does not allow using one state's prospectus in another state
where the second state provides a conforming procedure.
In states that have adopted the Small Corporate Offering
Registration (``SCOR'') Review Statement of Policy, information on
an issuer is available to investors through Form U-7. The Form U-7
contains a series of 50 very detailed questions on the issuer's
business, intended use of proceeds, management, principal
stockholders, and plan of distribution. In addition, the issuer must
file historical financial statements prepared in accordance with
generally accepted accounting principles in the United States. Form
U-7 has been either formally adopted or recognized and accepted by
45 states.
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If the transaction is effected under a state law exemption
that permits general solicitation and general advertising so long as
sales are made only to ``accredited investors.'' \38\
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\38\ Generally, these securities may not be freely transferred
under state law. The Model Accredited Investor Exemption provides
that any resale of a security sold in reliance of the exemption
within 12 months of sale will be presumed to be with a view to
distribution and not for investment, a requirement of the exemption,
except for limited circumstances. With respect to general
solicitation and advertising, the Model Accredited Investor
Exemption specifies that only a tombstone ad may be used; however, a
few states have no restriction on general solicitation and
advertising so long as sales are only made to accredited investors.
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These amendments will be effective April 7, 1999. Rule 504
offerings that begin on or after this date will have to comply with the
new rule. With respect to Rule 504 offerings that are ongoing at the
time of the amendments, issuers will have to discontinue offers and
register under a state law requiring the preparation and delivery of a
disclosure document to investors before sale in order to issue freely
tradable securities.
The pre-1992 approach strikes an appropriate balance between the
needs of legitimate small businesses to issue freely tradable
securities to obtain seed capital, while still protecting
investors.\39\ The amendments will preserve an avenue for small
businesses to issue freely tradable securities and not suffer deep
liquidity discounts, while at the same time they will protect investors
by curbing the use of Rule 504 securities in connection with fraudulent
transactions.
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\39\ We have an ongoing dialogue with small business and their
representatives. Since September 1996, we have hosted 12 SEC Small
Business Town Hall Meetings across the country to discuss issues
like our capital formation rules. We learn about the current
concerns and problems of small businesses in raising capital in the
securities markets so that we can implement programs to meet their
needs consistent with the protection of investors. Three meetings
have been held since the proposals were issued. At each meeting, we
discussed the Rule 504 Proposing Release and encouraged attendees to
submit their views as part of the rulemaking process.
In addition, every year we host the Government-Business Forum on
Small Business Capital Formation. In September 1998, we held the
Seventeenth Annual Forum in Chicago. The Rule 504 Proposing Release
generated significant discussion there as well.
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III. Cost-Benefit Analysis
In the Rule 504 Proposing Release we asked the public for their
views on the costs and benefits of the proposal and other supporting
information. No commenter provided data on the plan we adopt today.
We believe that those who will rely on the rule will not have
significantly increased costs. In fact, since the rule is essentially
being maintained as it has always operated, given the necessity of
state law compliance, the vast majority of issuers should have no
additional costs of compliance. The main impact will be that issuers
who make offerings in states that do not provide for the registration
provision dictated by the rule will have to register in another state
in order to have a public offering and issue that state's residents
freely tradable securities. We understand that issuers who intend to
issue securities in New York and the District of Columbia are the only
ones that will be affected by this change. We understand that the
average cost of preparing and filing a Form U-7 filing is $30,000.\40\
It is because of the mandate of investor protection that we are making
this change. Overall, the rule will maintain the benefits that allow
small companies to raise ``seed capital'' with a minimal federal
compliance scheme for public offerings. Private offerings also are
being affected since they will no longer be able to use general
solicitation or advertising and securities issued in these offerings
will be restricted. The Commission has concluded that the amendments
will not result in significant adverse effects on efficiency,
competition, or capital formation.
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\40\ This estimate is from a 1997 survey conducted by the SCOR
Report, a newsletter that covers all aspects of small business
finance.
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IV. Summary of the Final Regulatory Flexibility Analysis
In accordance with 5 U.S.C. Sec. 604, we have prepared a final
Regulatory Flexibility Analysis (``FRFA'') regarding the amendments.
The analysis notes that the amendments to Rule 504 are a result of
our view that the current configuration of the exemption may be leading
to abuse, as well as concerns expressed to us by representatives of
other regulators. The purpose of the revisions is to reduce the
potential for abuse and yet maintain the utility of the exemption for
small businesses. We have determined that the amendments will enhance
the protection of the investing public.
As the FRFA describes, in calendar year 1998, 2,988 Forms D were
filed by 2,499 companies with the Commission claiming the Rule 504
exemption. Rule 504 only affects non-reporting companies. The
Commission has sought to minimize the reporting burden on small
businesses. However, we do not collect data to determine how many of
the non-reporting companies filing Form D are small businesses. The
amendments will only affect issuers offering and selling in certain
jurisdictions. We do not know the number of Rule 504 offerings in these
jurisdictions. Therefore, we are unable to determine exactly how many
small businesses will be affected by the proposed amendments.
While it is not possible to know with certainty, it is believed
that most of these offerings were done by small businesses. Small
businesses affected by the changed rule include those that make a
``public'' offering of securities in one of the jurisdictions that does
not require prospectus delivery before sale. The rule changes would
require the securities to be registered in a state that requires
prospectus delivery before sale or that exempts general solicitations
of accredited investors. In the alternative, these companies could use
the rule to make a private offering, which could involve their offering
a liquidity discount for their shares and thus increase their cost for
capital. The Commission has insufficient data to
[[Page 11094]]
reliably quantify the impact on small entities offering such a
discount.
The amendments do not impose any new recordkeeping requirements or
require reporting of additional information. The amendments require
issuers in certain jurisdictions to register in states they might not
otherwise register. We understand that the average cost of a Form U-7
filing is $30,000.\41\
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\41\ See fn. 40, above.
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As discussed more fully in the FRFA, several possible significant
alternatives to the proposals were considered. These included
establishing different compliance or reporting requirements for small
entities, exempting them from all or part of the proposed requirements,
or requiring them to provide more disclosure, such as the same
disclosure as required for the other Regulation D exemptions. We also
considered restricting the resale of these securities. We concluded
that the costs of this proprosal exceeded the benefit. The FRFA also
indicates that there are no current federal rules that duplicate,
overlap, or conflict with the proposed rule amendments.
We encouraged written comments on any aspect of the initial
regulatory flexibility analysis (IRFA), but received no specific
comments in response to our request. In particular, we sought comment
on: (1) the number of small entities that would be affected by the
proposed rule amendments; and (2) the determination that the proposed
rule amendments would not increase the reporting, recordkeeping and
other compliance requirements for small entities. A copy of the FRFA
may be obtained from Twanna M. Young, Office of Small Business,
Division of Corporation Finance, Securities and Exchange Commission,
450 Fifth Street, NW, Washington, DC 20549.
V. Paperwork Reduction Act
We submitted the initial proposal for review in accordance with the
Paperwork Reduction Act of 1995 (``the Act'').\42\ The title to the
affected information collection is: ``Form D.'' The specific
information that must be included in Form D is explained in the form
itself, and relates to the issuer, its principals and the amount of
money proposed to be raised along with proposed applications of the
proceeds. The information is needed for monitoring use of the exemption
as well as evaluating its usefulness. The effect of the rule amendment
is to require some issuers to prepare registration and disclosure
documents they currently are not required to file.
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\42\ 44 U.S.C. 3501 et seq.
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The collection of information in Form D will continue to be
required in order for companies to use the rule for sales of their
securities. While we cannot estimate the number of respondents that may
use revised Rule 504, in calendar year 1998, there were 2,988 Forms D
filed by 2,499 companies with the Commission claiming the Rule 504
exemption. We believe that the vast majority of these were private Rule
504 offerings. We expect that approximately 2,250 companies each year
will be relying on the exemption. With the revisions to Rule 504 the
estimated burden for responding to the collection of information in
Form D would not increase for most companies because the information
required has not been changed. The number of eligible transactions,
however, may decrease. We do not know how many issuers currently offer
or sell securities pursuant to Rule 504 in states without a requirement
to deliver a disclosure document to investors before sale. We estimate
that the burden hours per respondent each year will be unchanged at 16.
Therefore, we estimate an aggregate of 36,000 burden hours per year.
The information collection requirements imposed by Form D are
mandatory to the extent that a company elects to use the Rule 504
exemption. The information will be disclosed to third parties or the
public. An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a currently valid control number. The OMB control number is 3235-0076.
We received no comments in response to our solicitation of comments
regarding the information collection obligation.
VI. Statutory Basic, Text of Amendments and Authority
The amendments are made pursuant to Sections 2, 3(b), 6, 7, 8, 10,
19(a), 19(c) and 28 of the Securities Act.
List of Subjects in 17 CFR Part 230
Reporting and recordkeeping requirements, Securities.
For the reasons set out in the preamble, title 17, chapter II of
the Code of Federal Regulations is amended as follows:
PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
1. The authority citation for part 230 continues to read in part as
follows:
Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77r, 77s, 77sss,
78c, 78d, 78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 80a-24, 80a-
28, 80a-29, 80a-30, and 80a-37, unless otherwise noted.
* * * * *
2. By revising Sec. 230.504(b)(1) to read as follows:
Sec. 230.504 Exemption for limited offerings and sales of securities
not exceeding $1,000,000.
* * * * *
(b) Conditions to be met. (1) General conditions. To qualify for
exemption under this Sec. 230.504, offers and sales must satisfy the
terms and conditions of Secs. 230.501 and 230.502 (a), (c) and (d),
except that the provisions of Sec. 230.502 (c) and (d) will not apply
to offers and sales of securities under this Sec. 230.504 that are
made:
(i) Exclusively in one or more states that provide for the
registration of the securities, and require the public filing and
delivery to investors of a substantive disclosure document before sale,
and are made in accordance with those state provisions;
(ii) In one or more states that have no provision for the
registration of the securities or the public filing or delivery of a
disclosure document before sale, if the securities have been registered
in at least one state that provides for such registration, public
filing and delivery before sale, offers and sales are made in that
state in accordance with such provisions, and the disclosure document
is delivered before sale to all purchasers (including those in the
states that have no such procedure); or
(iii) Exclusively according to state law exemptions from
registration that permit general solicitation and general advertising
so long as sales are made only to ``accredited investors'' as defined
in Sec. 230.501(a).
* * * * *
Dated: February 25, 1999.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-5295 Filed 3-5-99; 8:45 am]
BILLING CODE 8010-01-U
