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.

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 (1) registered

under state law requiring public filing and delivery of a

disclosure document to investors before sale, or (2) 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: [insert date 30 days after publication in the

Federal Register].

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, N.W., Washington, D.C. 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:

* 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]

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]

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.

Unfortunately, there have been recent disturbing

developments in the secondary markets[13] for some securities

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.

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

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]

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:

* after the one-year holding period of Rule 144[22];

* through registration; or

* through another exemption (such as Regulation A[23]), if

available.

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]

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 permitting a public offering are met. These

conditions are:

* 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]

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]

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.

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.

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]

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.

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 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

* 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]

These amendments will be effective [insert date 30 days

after publication in the Federal Register.] 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.

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.

IV. SUMMARY OF THE FINAL REGULATORY FLEXIBILITY ANALYSIS

In accordance with 5 U.S.C. §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

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]

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, N.W., Washington, D.C. 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.

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 BASIS, 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

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 §230.504(b)(1) to read as follows:

§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

§230.504, offers and sales must satisfy the terms and conditions

of §§230.501 and 230.502(a), (c) and (d), except that the

provisions of §230.502(c) and (d) will not apply to offers and

sales of securities under this §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 §230.501(a).

*****

By the Commission.

Jonathan G. Katz
Secretary

February 25, 1999

**FOOTNOTES**

[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.

[4]: See Release No. 33-6389 at Section II.A.

[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.

[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.

[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.

[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].

[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).

[22]: 17 CFR 230.144.

[23]: 17 CFR 230.251 et seq.

[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).

[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.

[26]: See Rule 501(a) of Regulation D.

[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.

[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].

[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."

[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.

[35]: Rule 502(b)(1) of Regulation D [17 CFR 230.501(b)(1)].

[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.

[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.

[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.

[40]: This estimate is from a 1997 survey conducted by the SCOR Report, a
newsletter that covers all aspects of small business finance.

[41]: See fn. 40, above.

[42]: 44 U.S.C. 3501 et seq.