Rule 504 of Regulation D: A Small Entity Compliance Guide for Issuers[1]

January 20, 2017

 

1. Overview

Rule 504 of Regulation D provides an exemption from registration under the Securities Act of 1933 for the offer and sale of up to $5,000,000 of securities in a 12-month period.[2]

2. Eligibility

The following companies are not eligible to use the Rule 504 exemption:

  • companies that already are Exchange Act reporting companies;
  • investment companies;
  • companies that have no specific business plan or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies; and
  • companies that are disqualified under Rule 504’s “bad actor” disqualification provisions.

3. Form D Notice

A company conducting an offering under Rule 504 (an “issuer”) is required to file a notice with the Commission on Form D within 15 days after the first sale of securities in the offering.  The Commission does not charge any fee to file or amend a Form D.  For more information on filing and amending a Form D, please see the resources referenced at the end of this guide.

4. General Prohibition on General Solicitation and Issuance of Restricted Securities

In general, issuers relying on Rule 504 may not use general solicitation or advertising to market the securities and purchasers will receive restricted securities.[3]  Investors in such offerings should be informed that they may not be able to sell the securities for at least a year unless the issuer registers the resale transaction with the Commission.

General solicitation and advertising is permitted and investors receive non-restricted securities,[4] however, if the issuer offers and sells the securities:

  • exclusively under one or more state laws that require registration, public filing and delivery to investors of a substantive disclosure document before sale;
  • in one or more states that do not have a provision requiring registration, public filing and delivery of a disclosure document before sale, so long as: the securities have been registered in at least one other state that provides for such registration, public filing and delivery before sale;  the issuer offers and sells securities in that other state under those provisions; and the issuer delivers to all purchasers in any state the disclosure documents mandated by the state in which it registered the securities; or
  • exclusively in a state according to an exemption in such state that permits general solicitation and advertising, so long as sales are made only to “accredited investors.”[5]

5. Bad Actor Disqualification

Rule 504 offerings are subject to the disqualification provisions found in Rule 506 of Regulation D.  The “bad actor” disqualification provisions disqualify offerings from relying on Rule 504 if the issuer or other “covered persons” have experienced a disqualifying event, such as being convicted of, or sanctioned for, securities fraud or other violations of specified laws. 

Covered Persons

Understanding the categories of persons that are covered is important because issuers are required to conduct a factual inquiry to determine whether any covered person has had a disqualifying event, and the existence of such an event will generally disqualify the offering from reliance on the Rule 504 exemption.

“Covered persons” include:

  • the issuer, including its predecessors and affiliated issuers;
  • directors, officers, general partners or managing members of the issuer;
  • beneficial owners of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power;
  • promoters connected with the issuer in any capacity at time of sale; and
  • persons compensated for soliciting investors, including the general partners, directors, officers or managing members of any such solicitor.

Disqualifying Events

Disqualifying events include:

  • Certain criminal convictions;
  • Certain court injunctions and restraining orders;
  • Certain final orders of certain state and federal regulators;
  • Certain SEC disciplinary orders;
  • Certain SEC cease-and-desist orders;
  • Suspension or expulsion from membership in a self-regulatory organization (SRO), such as FINRA, or being barred from association with an SRO member;
  • SEC stop orders and orders suspending the Regulation A exemption; and
  • U.S. Postal Service false representation orders.

Many of these events are only disqualifying if they occurred during  a look-back period (for example, a court injunction that was issued within the last five years or a regulatory order that was issued within the last ten years).  The look-back period is measured by counting back from the date of sale of securities in the Rule 504 offering to the date of the potentially disqualifying event – for example, the issuance of the injunction or regulatory order and not the date of the underlying conduct that led to the disqualifying event.

Disqualification under Rule 504 will not arise as a result of disqualifying events relating to any conviction, order, judgment, decree, suspension, expulsion or bar that occurred before January 20, 2017, the effective date of the Rule 504 amendment that added disqualifications.  Events that occurred prior to January 20, 2017 that are within the relevant look-back period and would otherwise be disqualifying are, however, required to be disclosed in writing to each purchaser.

Exceptions and Waivers

The rule provides an exception from disqualification when the issuer is able to demonstrate that it did not know and, in the exercise of reasonable care, could not have known that a covered person with a disqualifying event participated in the offering.

The specific steps an issuer should take to exercise reasonable care will vary according to particular facts and circumstances.  An instruction to the rule states that an issuer will not be able to establish that it has exercised reasonable care unless it has made, in light of the circumstances, a factual inquiry into whether any disqualifications exist.

Disqualification under Rule 504 will not arise if, before any sales are made in the Rule 504 offering, the court or regulatory authority that entered the relevant order, judgment or decree advises in writing – whether in the relevant judgment, order or decree or separately to the Commission or its staff – that disqualification under the rule should not arise as a consequence of such order, judgment or decree.

The rule also provides for the ability to seek waivers from disqualification by the Commission upon a showing of good cause that it is not necessary under the circumstances that the exemption be denied. 

6. Relationship with State Securities Laws

Issuers must comply with state securities laws and regulations in the states in which securities are offered or sold.  Each state’s securities laws have their own registration requirements and exemptions to registration requirements.  Issuers wishing to obtain information should contact state securities regulators in the states in which they intend to offer or sell securities for further guidance on compliance with state law requirements.  Issuers may also obtain useful information on state securities law registration requirements and exemptions to registration requirements, including coordinated state review programs, by visiting the website of the North American Securities Administrators Association (NASAA) at www.nasaa.org.

7. Other Resources

The adopting release increasing the aggregate amount of securities that may be offered and sold under Rule 504 from $1 million to $5 million and applying bad actor disqualifications to Rule 504 offerings can be found on the SEC’s website at https://www.sec.gov/rules/final/2016/33-10238.pdf.

Rule 504 (17 CFR 230.504) can be accessed through the “Corporation Finance” section of the SEC’s website at http://www.sec.gov/divisions/corpfin/ecfrlinks.shtml.

For guidance on Form D, please see the following:

Additional materials regarding the requirements of Rule 504, Regulation D and Form D are available at http://www.sec.gov/divisions/corpfin/cfguidance.shtml.

You can also submit complaints or tips about possible securities laws violations on the SEC’s questions and complaints page at http://www.sec.gov/complaint.shtml.

8. Contacting the SEC Staff

The SEC staff is happy to assist with questions regarding Rule 504, Regulation D and Form D.  You may contact the Division of Corporation Finance’s Office of Small Business Policy online or by telephone at (202) 551-3460.


[1] This guide was prepared by the staff of the U.S. Securities and Exchange Commission (the "Commission") as a "small entity compliance guide" under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains the rules adopted by the SEC, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.

[2] On October 26, 2016, the Commission adopted amendments to Rule 504 that increase the aggregate amount of securities that may be offered and sold from $1 million to $5 million and apply bad actor disqualifications to Rule 504 offerings.  These amendments were effective on January 20, 2017.

[3] Restricted securities are securities acquired in unregistered, private sales from the issuer or from an affiliate of the issuer and subject to the resale limitations of Regulation D.  Under Rule 144, purchasers of restricted securities who are not affiliated with the issuer may not resell the securities until one year after the date of their original purchase from the issuer, unless the issuer has filed an effective resale registration statement covering the offer and sale of those securities or a valid Securities Act exemption is available.  Under Rule 144, purchasers who are affiliated with the issuer are subject to a one-year holding period before they may resell and thereafter volume limitations and manner of sale requirements for equity securities, unless the offer and sale is registered with the Commission.  See Investor Publications: Rule 144: Selling Restricted and Control Securities

[4] An investor that wishes to sell securities that are not restricted must either register the transaction or have an exemption for the transaction.  An exemption commonly relied upon for the resale of the securities is Section 4(a)(1) of the Securities Act which is available to any person other than an issuer, underwriter or dealer.  Regulation D’s exemption from Securities Act registration 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. 

[5] In the context of a natural person, an accredited investor includes anyone who has: income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, or has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).  Entities such as banks, partnerships, corporations, nonprofits and trusts may also be accredited investors.  Depending on the circumstances, the following are examples of the types of entities that may be accredited investors: any trust, with total assets in excess of $5 million, not formed to specifically purchase the subject securities and whose purchase is directed by a sophisticated person, or any entity in which all of the equity owners are accredited investors.  See Securities Act Rule 501 and Investor Bulletin: Accredited Investors.