This blog covers the following topics:
Feel free to scroll down to the topic that interests you most.
Definition of a security
Securities must be registered with the SEC
Rules exempting securities from registration
Review of Regulation D Rules
Argument: Filing Form D is not optional
Consequences of failing to file Form D
How to file Form D
As many of my readers know, I have spent the greater part of my 17 years of law practice working with technology startups. Invariably, these startups are thirsty for capital from investors to fund their brilliant and innovative ideas. While acceptance of investor funds triggers questions related to securities compliance, there are often misunderstandings about how to comply. In particular, there is a pervasive misbelief that the action of filing Form D as prescribed under Regulation D is optional. The purpose of this blog is to dispel this belief.
Definition of a Security
We begin our analysis with a short discussion of what constitutes a “security”. Whenever a person makes an investment of value into a common enterprise with an expectation of profits derived from the efforts of others, the investment constitutes a securities transaction that triggers regulatory oversight and compliance from the Securities and Exchange Commission. It is this broad approach to defining what is a security that has captured initial coin offerings (ICOs), initial exchange offerings (IEOs), and even air-drops of cryptocurrencies into the securities regulatory framework. Incidentally, convertible notes, SAFE agreements, and SAFT agreements are also recognized securities instruments under the same Howey analysis.
Securities Must be Registered with the SEC
Continuing, it’s important to recognize that “… every offer and sale of securities, even if it is just to one person, must either be registered with the SEC or conducted under an exemption from registration.” When the SEC says all securities much be registered, it means registered with a public stock exchange. Consequently, the idea that there is some exception for a “friends and family round” is a myth. Of course, startups cannot afford to take-on the cost of a public registration, nor is a public registration always advisable for larger privately-held companies. Thus, in order to conduct a private offering of securities, the company doing the fundraising has to rely on some available exemption from the requirement to register all securities offerings.
Rules Exempting Securities from Registration
To facilitate small business capital formation, the SEC has developed several exemptions from the securities registration mandate. Among them are the original 4(2) exemption (now 4(a)(2) under the JOBS Act), Regulation D, Regulation Crowdfunding, Regulation A, intrastate offerings, and employee benefit plans. Historically, securities lawyers helped businesses accept investor funds through the use of 4(a)(2) that exempts from registration “… transactions by an issuer not involving any public offering.” Under this law, whether an offering constitutes a public offering largely depends on a number of variables, including the number and sophistication of the investors, the size and manner of the offering, and the relationship of the investors to the issuer. While a 4(a)(2) offering provides exemption from public registration, it does not grant automatic compliance with the individual state securities regulations called Blue Sky Laws. Consequently, any private issuer relying on this exemption from registration must also comply with the securities regulations of each state where the securities are offered. Further, investors must be given access to the type of information that would be included in a public registration statement. It makes sense then that due to inconsistencies in how courts have interpreted and applied these factors, the SEC later adopted Regulation D as a non-exclusive safe harbor that allows issuers to conduct limited offerings and sales of securities without registration under the Securities Act of 1933.
Review of Regulation D Rules
Regulation D can be found in the electronic Code of Federal Regulations (eCFR) sections 230.500 – 230.508. Following is a summary of each of the rules contained in Regulation D which is helpful to the determination that filing Form D is mandated in each and every offering made in reliance on Regulation D as the available registration exemption.
Rule 500 gives the reader background information about Regulation D, noting with particularity that while compliance with Regulation D provides companies safe harbor from varying state securities regulations, it does not exempt companies from compliance with the antifraud, civil liability, or other provisions of the federal securities laws. Thus, issuers must disclose, disclose, disclose!
Rule 501 provides definitions and terms as they are used throughout Regulation D. For example, the definition of an accredited investor can be found here.
Rule 502 gives information about general conditions that must be met with relying upon Regulation D in private offering. For example, rules regarding the integration of concurrent offerings can be found here, as well as the kind of information a securities issuer is required to provide to investors depending on the size and nature of the offering, and whether it involves unaccredited investors. Spoiler alert, the issuer must always provide to the investor all of the information about the company that an investor would find material to their decision of whether to invest. Yes, this is vague and ambiguous. So, if you are aren’t sure whether something is required to be disclosed, the best course is usually to error on the side of disclosure
Rule 503 is the tricky one that folks love to ignore. This Rule mandates that an issuer offering securities in reliance upon either Rule 504 or Rule 506 of Regulation D must file Form D with the SEC using EDGAR no later than 15 calendar days after the first sale of securities in the offering. More on this, later.
Rule 504 provides issuers with an exemption for limited offerings and sales of securities not exceeding $5,000,000.
Rule 505 used to be its own exemption but has since been repealed under the JOBS Act. This Rule is now “reserved” for reuse by the SEC in case they need it.
Rule 506 is the most popular exemption for private issuers of securities because of the safe harbor it affords those who comply. It is comprised of subsections (b) and (c), each granting the issuer the opportunity to conduct a private placement exempt from registration, and which preempt state blue sky laws. Notably, accredited investor verification requirements and bad actor disqualification rules are located here.
Rule 507 states that exemptions under Rules 504 and 506 shall not be available for an issuer if it, or its predecessors or affiliates have been adjudged to have failed to file Form D, unless, upon a showing of good cause, the SEC determines that filing Form D was not necessary under the circumstances.
Rule 508 explains that failure to comply with a term, condition, or requirement of Rules 504 or 506 will not automatically result in the loss of the exemption under limited circumstances.
Argument: Filing Form D is Not Optional
In my practice, I have run into situations where other lawyers are advising their clients NOT to file Form D because doing so requires the issuer of securities to disclose information on the form they might not want folks to know about. For example, the form requires the issuer to disclose the identity of its directors, officers, and promoters, the total offering amount and sold offering, the type of securities sold, where they have been sold, and compensation paid to securities brokers. Because Rule 506 only identifies Rules 501 and 502 as conditions for qualification, and not Rule 503, people mistakenly believe they do not have to file Form D as required by 503 in order to claim a 506 exemption. Because Rule 508 states an insignificant deviation from a term, condition or requirement of Regulation D will not result in the loss of the exemption, folks further argue that filing Form D is “no big deal” and it won’t result in any consequences. Based on my conversations with folks about this, I understand they think it’s no big deal because in response to Question 257.08 of the SEC Compliance and Disclosure Interpretations (CD&I) says that “[f]iling a Form D is not a condition that must be met to qualify for the Rule 506 exemption.”
The problem with the above arguments in favor of not filing the form is that it requires the issuer to disregard Rule 503. You see, both the exemptions available under Rules 504 and 506 are part of a larger regulatory framework titled Regulation D of which Rule 503 is a part. To confirm this, on 9 November 2020, I spoke with an SEC attorney who works in the Corporate Finance Division. This gentleman, whose name and contact information I am not authorized to release, was adamant failure to file the form is a clear violation of Rule 503, and thus a violation of Regulation D, for which is there is no excuse. Consequently, violation of Rule 503 may result in grave consequences for the issuer and the offering. He even went on to state that even a late filing of the form is its own violation. I cannot overstate just how serious this gentleman was about this issue. In fact, he even suggested he intends to notify the appropriate authority within the SEC about the misuse of CD&I 257.08 to determine whether it should be revised.
Another argument often made in favor of not filing is that if for any reason the Regulation D exemption is not available, the issuer could always fall back in reliance on the 4(a)(2) exemption described above in this blog. Recalling that the 4(a)(2) exemption does not provide safe harbor from Blue Sky regulations, the issuer would have to do a full examination of the facts and circumstances of each and every offering in relation to the federal securities laws and that of each state involved in the offering to determine whether a 4(a)(2) exemption is even available. Further, the disclosures made at the time of the offering must have risen to the level required, and in my experience, that rarely happens.
Consequences of failing to File Form D
The registration exemptions under Rules 504 and 506 are designed to help small businesses fundraise without the cost of having to comply with a myriad of state securities rules. Securities issued in reliance on these exemptions are “covered” from having to comply with individual state securities Blue Sky laws. While failure to file Form D does not automatically remove this protective coverage, it is not without consequence. Historically, “[u]nder Regulation D as adopted in 1982, an otherwise valid offering was destroyed by a delinquently filed Form D.” Criticized for this strict requirement, the SEC then amended the rules to eliminate the requirement to file Form D as a condition to federally preemptive coverage. However, as Rule 507 states, issuers caught failing to file Form D may result in the issuer being disqualified from making future offerings under the rules.
Willfully failing to file Form D is a felony.
As explained above, the Attorney with whom I spoke at the SEC explained that issuers conducting Regulation D offerings but who fail to file Form D are in violation of Rule 503. He further confirmed that the SEC can and does bring enforcement actions for failure to file. He personally attested that he has seen several enforcement actions that “failure to file Form D” as a basis for bringing an enforcement action. The SEC Commissions Opinions and Adjudicatory Orders webpage does not enable a general search of its contents, so I cannot easily provide evidence of this Attorney’s assurance that the SEC does take Rule 503 violations seriously and does enforce them. However, a search of the legal database LexisNexis returns an abundance of case law discussing this issue.
While the National Securities Marketing Improvement Act (NSMIA) prohibits states from requiring the separate registration of covered securities, it does allow states to require issuers to file any document filed with the SEC “solely for notice purposes and the assessment of any fee.” Additionally, the Congress allowed the states to suspend offers or sales for failure to file or pay a fee. Consequently, failure to file Form D may invalidate the offering at the state level. Moreover, “[s]ince a willful violation of Rule 503 is a felony under the Securities Act section 24, it is unlikely that the Commission or a court would allow someone who knows the form is to be filed, and purposely fails to file it, to have the benefit of a Regulation D exemption.”
In conclusion, possible consequences for failing to file Form D include:
State invalidation of the offering
Rescission of the offering
Securities enforcement action for violation of Rule 503
Criminal charges that may result in prison time
Fines and penalties
How to File Form D
Federal Filings: Filing Form D with SEC is free, easy, and protects the integrity of your offering. Rule 503 explains that Form D must be filed with the SEC Electronic Data Gathering, Analysis, and Retrieval System (EDGAR) within 15 days of having closed the first sale of securities in the offering. The SEC provides further guidance on how to file Form D on its small business webpage under exempt offerings. For additional SEC staff guidance about Form D is also included within the CD&I related to Securities Act Forms. When opening the footnoted link in your web browser, Ctrl+F will open the general page search function into which you can type “Form D” to bring up relevant hits. Additional CD&I about Form D can be accessed by searching the general Compliance and Disclosure Interpretations site under the category “Securities Act”.
State Filings: Recalling that the NSMIA does allow states to require notice and fee assessment for covered securities offerings, all issuers must verify the rules for the state in which the issuer is registered and all states where each investor resides. Each state will have its own division of securities that provides information on whether issuers need to file a copy of Form D and associated fees. In Florida where I am licensed to practice, securities offerings are regulated by the Office of Financial Regulation and they do not want a copy of Form D, nor do they collect any fees. In contrast, the Ohio Division of Securities requires a copy of Form D to be filed with them together with the payment of $100. Notably, New York operates a little differently. Incidentally, New York is especially tricky in this regard and requires special attention. In an effective circumvention of the federal rules of preemption for covered securities, the New York Martin Act regulates dealers and issuers of their own securities. In New York, issuers must provide a notice prior to engaging in any offering, and a second notice may also be required depending on the facts. Thus, Rule 506 compliant offerings typically commence with a filing of New York Form 99 in addition to Form D. Associated fees vary depending on the size of the offering.
For more information on this topic or what you can do to remedy a failure to file Form D, please feel free to contact me via email at firstname.lastname@example.org.
 See SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (Establishing the infamous 4-part Howey test that provides a broad and flexible approach to determining what is a security).  See SEC v. Sierra Brokerage Servs., 608 F. Supp. 2d 923, (S.D. Ohio 2009) (Whereas, a bona fide gift of a security would not constitute a sale, but if the donor derives some benefit, or if it disperses corporate ownership and creates a market for subsequent sales, a gift constitutes a sale of a security).  U.S. SEC Information for Small Businesses. https://www.sec.gov/smallbusiness.  U.S. SEC Exempt Offerings. https://www.sec.gov/smallbusiness/exemptofferings.  15 U.S.C. § 77d(a)(2) https://www.law.cornell.edu/uscode/text/15/77d.  Deepak, S., n.d. Blue Sky Law. [online] LII / Legal Information Institute. Available at: https://www.law.cornell.edu/wex/blue_sky_law.  Supra.  See SEC v. Murphy, 626 F.2d 633 (9th Cir. 1980).  17 CFR §230.500 et al. https://www.ecfr.gov/cgi-bin/text-idx?SID=39219c53164c0a2a7eeea46205d6d615&mc=true&tpl=/ecfrbrowse/Title17/17cfr230_main_02.tpl.  SEC Compliance and Disclosure Interpretations: Question 256.13. (“In analyzing this or any other disclosure question under Regulation D, the issuer starts with the general rule that it is obligated to furnish the specified information ‘to the extent material to an understanding of the issuer, its business, and the securities bring offered.’” [Jan. 26, 2009])  J. Williams Hicks, 7A Exempted Trans. Under Securities Act 1933 § 7:231 (2003).  See Id.; see also Securities and Exchange Commission Summary, Regulation D; Accredited Investor and Filing Requirements, 54 Fed. Reg. 11369 (March 20, 1989).  15 U.S.C. § 77r(c).  See Id.  Larry D. Soderquist, Securities Act Registration Exemptions, 1490 PLI/Corp 265, 289 (2005).  https://www.sec.gov/smallbusiness/exemptofferings/formd.  https://www.sec.gov/corpfin/securities-act-forms.  https://www.sec.gov/divisions/corpfin/cfguidance.shtml.  https://www.flofr.com/sitePages/DivisionOfSecuritiesFAQ.htm.  https://www.com.ohio.gov/secu/default.aspx.  https://www.com.ohio.gov/documents/formd.pdf.  https://ag.ny.gov/sites/default/files/form99.pdf.  Shulga, A., 2015. How To Comply With New York Blue Sky Laws. [online] LexisNexis® Legal Newsroom. Available at: https://www.lexisnexis.com/legalnewsroom/corporate/b/business/posts/how-to-comply-with-new-york-blue-sky-laws.