Reverse Merger

Overview | Preparation | Pro's and Con's | Rules Regarding Shell Companies | SEC Information


SEC INFORMATION

The mission of the U.S. Securities and Exchange Commission (SEC) is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. Companies that report to the SEC have far more credibility in the eyes of investor’s then companies that do not report to the SEC.

The SEC's foundation was laid in an era that was ripe for reform. Before the Great Crash of 1929, there was little support for federal regulation of the securities markets. This was particularly true during the post-World War I surge of securities activity. Proposals that the federal government require financial disclosure and prevent the fraudulent sale of stock were never seriously pursued.

Tempted by promises of "rags to riches" transformations and easy credit, most investors gave little thought to the systemic risk that arose from widespread abuse of margin financing and unreliable information about the securities in which they were investing. During the 1920s, approximately 20 million large and small shareholders took advantage of post-war prosperity and set out to make their fortunes in the stock market. It is estimated that of the $50 billion in new securities offered during this period, half became worthless.

When the stock market crashed in October 1929, public confidence in the markets plummeted. Investors large and small, as well as the banks who had loaned to them, lost great sums of money in the ensuing Great Depression. There was a consensus that for the economy to recover, the public's faith in the capital markets needed to be restored. Congress held hearings to identify the problems and search for solutions.

Based on the findings in these hearings, Congress — during the peak year of the Depression — passed the Securities Act of 1933. This law, together with the Securities Exchange Act of 1934, which created the SEC, was designed to restore investor confidence in our capital markets by providing investors and the markets with more reliable information and clear rules of honest dealing. The main purposes of these laws can be reduced to two common-sense notions:
  • Companies publicly offering securities for investment dollars must tell the public the truth about their businesses, the securities they are selling, and the risks involved in investing.  
  • People who sell and trade securities – brokers, dealers, and exchanges – must treat investors fairly and honestly, putting investors' interests first.

Monitoring the securities industry requires a highly coordinated effort. Congress established the Securities and Exchange Commission in 1934 to enforce the newly-passed securities laws, to promote stability in the markets and, most importantly, to protect investors. President Franklin Delano Roosevelt appointed Joseph P. Kennedy, President John F. Kennedy's father, to serve as the first Chairman of the SEC.

As more and more first-time investors turn to the markets to help secure their futures, pay for homes, and send children to college, our investor protection mission is more compelling than ever.

As our nation's securities exchanges mature into global for-profit competitors, there is even greater need for sound market regulation.

And the common interest of all Americans in a growing economy that produces jobs, improves our standard of living, and protects the value of our savings means that all of the SEC's actions must be taken with an eye toward promoting the capital formation that is necessary to sustain economic growth.

The world of investing is fascinating and complex, and it can be very fruitful. But unlike the banking world, where deposits are guaranteed by the federal government, stocks, bonds and other securities can lose value. There are no guarantees. That's why investing is not a spectator sport. By far the best way for investors to protect the money they put into the securities markets is to do research and ask questions.

The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security. Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions.

The result of this information flow is a far more active, efficient, and transparent capital market that facilitates the capital formation so important to our nation's economy. To insure that this objective is always being met, the SEC continually works with all major market participants, including especially the investors in our securities markets, to listen to their concerns and to learn from their experience.

The SEC oversees the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. Here the SEC is concerned primarily with promoting the disclosure of important market-related information, maintaining fair dealing, and protecting against fraud.

Crucial to the SEC's effectiveness in each of these areas is its enforcement authority. Each year the SEC brings hundreds of civil enforcement actions against individuals and companies for violation of the securities laws. Typical infractions include insider trading, accounting fraud, and providing false or misleading information about securities and the companies that issue them.
There are two primary sets of federal laws that come into play when a company wants tp offer and sell securities to the public. They are:

Securities Act of 1933
Often referred to as the "truth in securities" law, the Securities Act of 1933 has two basic objectives:

  • require that investors receive financial and other significant information concerning securities being offered for public sale; and
  • prohibit deceit, misrepresentations, and other fraud in the sale of securities.
  • Securities Exchange Act of 1934
With this Act, Congress created the Securities and Exchange Commission. The Act empowers the SEC with broad authority over all aspects of the securities industry. This includes the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation's securities self regulatory organizations (SROs). The various stock exchanges, such as the New York Stock Exchange, and American Stock Exchange are SROs. The National Association of Securities Dealers, which operates the NASDAQ system, is also an SRO.

The Act also identifies and prohibits certain types of conduct in the markets and provides the Commission with disciplinary powers over regulated entities and persons associated with them.

The Act also empowers the SEC to require periodic reporting of information by companies with publicly traded securities.

Corporate Reporting
Companies with more than $10 million in assets whose securities are held by more than 500 owners must file annual and other periodic reports. These reports are available to the public through the SEC's EDGAR database.

Proxy Solicitations
The Securities Exchange Act also governs the disclosure in materials used to solicit shareholders' votes in annual or special meetings held for the election of directors and the approval of other corporate action. This information, contained in proxy materials, must be filed with the Commission in advance of any solicitation to ensure compliance with the disclosure rules. Solicitations, whether by management or shareholder groups, must disclose all important facts concerning the issues on which holders are asked to vote.

Tender Offers
The Securities Exchange Act requires disclosure of important information by anyone seeking to acquire more than 5 percent of a company's securities by direct purchase or tender offer. Such an offer often is extended in an effort to gain control of the company. As with the proxy rules, this allows shareholders to make informed decisions on these critical corporate events.

Insider Trading
The securities laws broadly prohibit fraudulent activities of any kind in connection with the offer, purchase, or sale of securities. These provisions are the basis for many types of disciplinary actions, including actions against fraudulent insider trading. Insider trading is illegal when a person trades a security while in possession of material nonpublic information in violation of a duty to withhold the information or refrain from trading.

Registration of Exchanges, Associations, and Others
The Act requires a variety of market participants to register with the Commission, including exchanges, brokers and dealers, transfer agents, and clearing agencies. Registration for these organizations involves filing disclosure documents that are updated on a regular basis.

The exchanges and the National Association of Securities Dealers (NASD) are identified as self-regulatory organizations (SRO). SROs must create rules that allow for disciplining members for improper conduct and for establishing measures to ensure market integrity and investor protection. SRO proposed rules are published for comment before final SEC review and approval.

Trust Indenture Act of 1939
This Act applies to debt securities such as bonds, debentures, and notes that are offered for public sale. Even though such securities may be registered under the Securities Act, they may not be offered for sale to the public unless a formal agreement between the issuer of bonds and the bondholder, known as the trust indenture, conforms to the standards of this Act.

Investment Company Act of 1940
This Act regulates the organization of companies, including mutual funds, that engage primarily in investing, reinvesting, and trading in securities, and whose own securities are offered to the investing public. The regulation is designed to minimize conflicts of interest that arise in these complex operations. The Act requires these companies to disclose their financial condition and investment policies to investors when stock is initially sold and, subsequently, on a regular basis. The focus of this Act is on disclosure to the investing public of information about the fund and its investment objectives, as well as on investment company structure and operations. It is important to remember that the Act does not permit the SEC to directly supervise the investment decisions or activities of these companies or judge the merits of their investments.

Investment Advisers Act of 1940
This law regulates investment advisers. With certain exceptions, this Act requires that firms or sole practitioners compensated for advising others about securities investments must register with the SEC and conform to regulations designed to protect investors. Since the Act was amended in 1996, generally only advisers who have at least $25 million of assets under management or advise a registered investment company must register with the Commission.

Sarbanes-Oxley Act of 2002
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, which he characterized as "the most far reaching reforms of American business practices since the time of Franklin Delano Roosevelt." The Act mandated a number of reforms to enhance corporate responsibility, enhance financial disclosures and combat corporate and accounting fraud, and created the "Public Company Accounting Oversight Board," also known as the PCAOB, to oversee the activities of the auditing profession.

What is “Edgar”:
Edgar is the SEC’s database of public company information that can be searched by the public at: www.sec.gov.

General-Purpose Searches
This search works best when you have a specific company in mind. "Search Companies and Filings" allows you to retrieve real-time filings for a specific company and to find key company information — including its name, address, telephone number, state of incorporation, Central Index Key (CIK) number, Standard Industrial Classification (SIC) code, and fiscal year end. Simply type in the name of the company or its CIK number.

Note: A CIK is the unique number that the SEC's computer system assigns to individuals and corporations who file disclosure documents with the SEC. All new electronic and paper filers, foreign and domestic, receive a CIK number. You don't need to know a company's CIK, but searching by that number will narrow your search to the exact company you want.

You can also search for all SEC-registered companies in a particular state. Or you can search for all companies with a specific SIC code. For example, if you enter 7370 in the SIC box, you'll retrieve all SEC-registered companies that fall into the Standard Industrial Classification known as "Services-Computer Programming, Data Processing, Etc."

Once you've found the company you want, you can limit the search results by date (for example, "Prior to 2002-01-01") or by the type of filing (for example, "10-K").

EDGAR CIK (Central Index Key) Lookup

The CIK is a unique identifier assigned by the SEC to all companies and people who file disclosures with the SEC. Simply enter the company's name and click on search to find the CIK. Then use the CIK (including the leading zeroes - e.g., 00001111) as a keyword in your Archives or Forms Lookup search.
Current Events Analysis

Retrieve filings made during the previous week. For example, you can check 10-K (annual) and 10-Q (quarterly) reports, proxies, and others. Simply select the desired time period and the form you'd like to see. Select "all" if you don't want to limit your search to a particular form.
Mutual Fund Prospectuses and Proxy Voting Records

To view prospectuses or proxy voting records for the mutual fund of your choice use the “mutual funds search feature”. Once you have found the share class of the mutual fund, you can narrow your search further to retrieve Prospectuses or Proxy Voting Records.
Variable Insurance Products

Find Variable Insurance Products and associated filings for new filings with series and class/contract name (filings since Feb. 6, 2006). See our Fast Answer on variable annuities for background information on these products.
Effectiveness Notices

Securities Act registration statements and post-effective amendments declared effective on the most recently completed business day.

How Does My Small Business Register a Public Offering?
If you decide on a registered public offering, the Securities Act requires your company to file a registration statement with the SEC before the company can offer its securities for sale. You cannot actually sell the securities covered by the registration statement until the SEC staff declares it "effective," even though registration statements become public immediately upon filing.
Registration statements have two principal parts:
  • Part I is the prospectus, the legal offering or "selling" document. Your company - the "issuer" of the securities - must describe in the prospectus the important facts about its business operations, financial condition, and management. Everyone who buys the new issue, as well as anyone who is made an offer to purchase the securities, must have access to the prospectus.
  • Part II contains additional information that the company does not have to deliver to investors. Anyone can see this information by requesting it from one of the SEC's public reference rooms or by looking it up on the SEC Web site.
The Basic Registration Form - Form S-1
All companies can use Form S-1 to register their securities offerings. You should not prepare a registration statement as a fill-in-the-blank form, like a tax return. It should be similar to a brochure, providing readable information. If you file this form, your company must describe each of the following in the prospectus:
  • its business;
  • its properties;
  • its competition;
  • the identity of its officers and directors and their compensation;
  • material transactions between the company and its officers and directors;
  • material legal proceedings involving the company or its officers and directors;
  • the plan for distributing the securities; and the intended use of the proceeds of the offering.

Information about how to describe these items is set out in SEC rules. Registration statements also must include financial statements audited by an independent certified public accountant.

In addition to the information expressly required by the form, your company must also provide any other information that is necessary to make your disclosure complete and not misleading. You also must clearly describe any risks prominently in the prospectus, usually at the beginning. Examples of these risk factors are:

  • lack of business operating history;
  • adverse economic conditions in a particular industry;
  • lack of a market for the securities offered; and
  • dependence upon key personnel.
Alternative Registration Forms for Small Business Issuers
If your company qualifies as a "small business issuer," it can choose to file its registration statement using one of the simplified small business forms. A small business issuer is a United States or Canadian issuer:
  • that had less than $25 million in revenues in its last fiscal year, and
  • whose outstanding publicly-held stock is worth no more than $25 million.
Form SB-1 - To Raise $10 Million or Less
Small business issuers offering up to $10 million worth of securities in any 12-month period may use Form SB1. This form allows you to provide information in a question and answer format, similar to that used in Regulation A offerings, a type of exempt offering discussed on page 19. Unlike Regulation A filings, Form SB-1 requires audited financial statements.

Form SB-2 - To Raise Capital in Any Amount
If your company is a "small business issuer," it may register an unlimited dollar amount of securities using Form SB-2, and may use this form again and again so long as it satisfies the "small business issuer" definition.

One advantage of Form SB-2 is that all its disclosure requirements are in Regulation S-B, a set of rules written in simple, non-legalistic terminology. Form SB-2 also permits the company to:
  • Provide audited financial statements, prepared according to generally accepted accounting principles, for two fiscal years. In contrast, Form S-1 requires the issuer to provide audited financial statements, prepared according to more detailed SEC regulations, for three fiscal years; and
  • Include less extensive narrative disclosure than Form S-1 requires, particularly in the description of your business, and executive compensation.
Staff Review of Registration Statements
SEC staff examines registration statements for compliance with disclosure requirements. If a filing appears incomplete or inaccurate, the staff usually informs the company by letter. The company may file correcting or clarifying amendments. Once the company has satisfied the disclosure requirements, the staff declares the registration statement effective. The company may then begin to sell its securities. The SEC can refuse or suspend the effectiveness of any registration statement if it concludes that the document is misleading, inaccurate, or incomplete.

If My Company Becomes Public, What Disclosures Must I Regularly Make?
Your company can become "public" in one of two ways - by issuing securities in an offering registered under the Securities Act or by registering the company's outstanding securities under Exchange Act requirements. Both types of registration trigger ongoing reporting obligations for your company. In some cases, the Exchange Act also subjects your company's officers, directors and significant shareholders to reporting requirements. Let's discuss these requirements individually.

Reporting obligations because of Securities Act registration
Once the staff declares your company's Securities Act registration statement effective, the Exchange Act requires you to file reports with the SEC. The obligation to file reports continues at least through the end of the fiscal year in which your registration statement becomes effective. After that, you are required to continue reporting unless you satisfy the following "thresholds," in which case your filing obligations are suspended:
  • your company has fewer than 300 shareholders of the class of securities offered; or
  • your company has fewer than 500 shareholders of the class of securities offered and less than $10 million in total assets for each of its last three fiscal years.
If your company is subject to the reporting requirements, it must file information with the SEC about:
  • its operations;
  • its officers, directors, and certain shareholders, including salary, various fringe benefits, and transactions between the company and management;
  • the financial condition of the business, including financial statements audited by an independent certified public accountant; and
  • its competitive position and material terms of contracts or lease agreements.
All of this information becomes publicly available when you file your reports with the SEC. As is true with Securities Act filings, small business issuers may choose to use small business alternative forms and Regulation S-B for registration and reporting under the Exchange Act.

Obligations because of Exchange Act registration
Even if your company has not registered a securities offering, it must file an Exchange Act registration statement if:
  • it has more than $10 million total assets and a class of equity securities, like common stock, with 500 or more shareholders; or
  • it lists its securities on an exchange or on Nasdaq.
If a class of your company's securities is registered under the Exchange Act, the company, as well as its shareholders and management, are subject to various reporting requirements, explained below.

Ongoing Exchange Act periodic reporting
If your company registers a class of securities under the Exchange Act, it must file the same annual, periodic, and current reports that are required as a result of Securities Act registration, as explained above. This obligation continues for as long as the company exceeds the reporting thresholds previously outlined on page 11. If your company's securities are traded on an exchange or on Nasdaq, the company must continue filing these reports as long as the securities trade on those markets, even if your company falls below the thresholds.

Proxy rules
A company with Exchange Act registered securities must comply with the SEC's proxy rules whenever it seeks a shareholder vote on corporate matters. These rules require the company to provide a proxy statement to its shareholders, together with a proxy card when soliciting proxies. Proxy statements discuss management and executive compensation, along with descriptions of the matters up for a vote. If the company is not soliciting proxies but will take a vote on a matter, the company must provide to its shareholders an information statement that is similar to a proxy statement. The proxy rules also require your company to send an annual report to shareholders if there will be an election of directors. These reports contain much of the same information found in the Exchange Act annual reports that a company must file with the SEC, including audited financial statements. The proxy rules also govern when your company must provide shareholder lists to investors and when it must include a shareholder proposal in the proxy statement.

Beneficial ownership reports
If your company has registered a class of its equity securities under the Exchange Act, persons who acquire more than five percent of the outstanding shares of that class must file beneficial owner reports until their holdings drop below five percent. These filings contain background information about the beneficial owners as well as their investment intentions, providing investors and the company with information about accumulations of securities that may potentially change or influence company management and policies.

Tender offers
A public company with Exchange Act registered securities that faces a takeover attempt, or third party tender offer, should be aware that the SEC's tender offer rules will apply to the transaction. The same is true if the company makes a tender offer for its own Exchange Act registered securities. The filings required by these rules provide information to the public about the person making the tender offer. The company that is the subject of the takeover must file with the SEC its responses to the tender offer. The rules also set time limits for the tender offer and provide other protections to shareholders.

Transaction reporting by officers, directors and ten percent shareholders
Section 16 of the Exchange Act applies to your company's directors and officers, as well as shareholders who own more than 10% of a class of your company's equity securities registered under the Exchange Act. It requires these persons to report their transactions involving the company's equity securities to the SEC. Section 16 also establishes mechanisms for a company to recover "short swing" profits, those profits an insider realizes from a purchase and sale of a company security within a six-month period. In addition, Section 16 prohibits short selling by these persons of any class of the company's securities, whether or not that class is registered under the Exchange Act.

Are There Legal Ways To Offer and Sell Securities Without Registering With the SEC?
Yes! Your company's securities offering may qualify for one of several exemptions from the registration requirements. We explain the most common ones below. You must remember, however, that all securities transactions, even exempt transactions, are subject to the antifraud provisions of the federal securities laws. This means that you and your company will be responsible for false or misleading statements, whether oral or written. The government enforces the federal securities laws through criminal, civil and administrative proceedings. Some enforcement proceedings are brought through private law suits. Also, if all conditions of the exemptions are not met, purchasers may be able to obtain refunds of their purchase price. In addition, offerings that are exempt from provisions of the federal securities laws may still be subject to the notice and filing obligations of various state laws. Make sure you check with the appropriate state securities administrator before proceeding with your offering.

A. Intrastate Offering Exemption
Section 3(a)(11) of the Securities Act is generally known as the "intrastate offering exemption." This exemption facilitates the financing of local business operations. To qualify for the intrastate offering exemption, your company must:
  • be incorporated in the state where it is offering the securities;
  • carry out a significant amount of its business in that state; and
  • make offers and sales only to residents of that state.
There is no fixed limit on the size of the offering or the number of purchasers. Your company must determine the residence of each purchaser. If any of the securities are offered or sold to even one out-of-state person, the exemption may be lost. Without the exemption, the company could be in violation of the Securities Act registration requirements. If a purchaser resells any of the securities to a person who resides outside the state within a short period of time after the company's offering is complete (the usual test is nine months), the entire transaction, including the original sales, might violate the Securities Act. Since secondary markets for these securities rarely develop, companies often must sell securities in these offerings at a discount.

It will be difficult for your company to rely on the intrastate exemption unless you know the purchasers and the sale is directly negotiated with them. If your company holds some of its assets outside the state, or derives a substantial portion of its revenues outside the state where it proposes to offer its securities, it will probably have a difficult time qualifying for the exemption.
You may follow Rule 147, a "safe harbor" rule, to ensure that you meet the requirements for this exemption. It is possible, however, that transactions not meeting all requirements of Rule 147 may still qualify for the exemption.

B. Private Offering Exemption
Section 4(2) of the Securities Act exempts from registration "transactions by an issuer not involving any public offering." To qualify for this exemption, the purchasers of the securities must:
  • have enough knowledge and experience in finance and business matters to evaluate the risks and merits of the investment (the "sophisticated investor"), or be able to bear the investment's economic risk;
  • have access to the type of information normally provided in a prospectus; and
  • agree not to resell or distribute the securities to the public.
In addition, you may not use any form of public solicitation or general advertising in connection with the offering.

The precise limits of this private offering exemption are uncertain. As the number of purchasers increases and their relationship to the company and its management becomes more remote, it is more difficult to show that the transaction qualifies for the exemption. You should know that if you offer securities to even one person who does not meet the necessary conditions, the entire offering may be in violation of the Securities Act.

Rule 506, another "safe harbor" rule, provides objective standards that you can rely on to meet the requirements of this exemption. Rule 506 is a part of Regulation D, which we describe more fully on page 24.

C. Regulation A
Section 3(b) of the Securities Act authorizes the SEC to exempt from registration small securities offerings. By this authority, we created Regulation A, an exemption for public offerings not exceeding $5 million in any 12-month period. If you choose to rely on this exemption, your company must file an offering statement, consisting of a notification, offering circular, and exhibits, with the SEC for review.

Regulation A offerings share many characteristics with registered offerings. For example, you must provide purchasers with an offering circular that is similar in content to a prospectus. Like registered offerings, the securities can be offered publicly and are not "restricted," meaning they are freely tradeable in the secondary market after the offering. The principal advantages of Regulation A offerings, as opposed to full registration, are:
  • The financial statements are simpler and don't need to be audited;
  • There are no Exchange Act reporting obligations after the offering unless the company has more than $10 million in total assets and more than 500 shareholders;
  • Companies may choose among three formats to prepare the offering circular, one of which is a simplified question-and-answer document; and
  • You may "test the waters" to determine if there is adequate interest in your securities before going through the expense of filing with the SEC.
All types of companies which do not report under the Exchange Act may use Regulation A, except "blank check" companies, those with an unspecified business, and investment companies registered or required to be registered under the Investment Company Act of 1940. In most cases, shareholders may use Regulation A to resell up to $1.5 million of securities.

If you "test the waters," you can use general solicitation and advertising prior to filing an offering statement with the SEC, giving you the advantage of determining whether there is enough market interest in your securities before you incur the full range of legal, accounting, and other costs associated with filing an offering statement. You may not, however, solicit or accept money until the SEC staff completes its review of the filed offering statement and you deliver prescribed offering materials to investors.

D. Regulation D
Regulation D establishes three exemptions from Securities Act registration. Let's address each one separately.

Rule 504
Rule 504 provides an exemption for the offer and sale of up to $1,000,000 of securities in a 12-month period. Your company may use this exemption so long as it is not a blank check company and is not subject to Exchange Act reporting requirements. Like the other Regulation D exemptions, in general you may not use public solicitation or advertising to market the securities and purchasers receive "restricted" securities, meaning that they may not sell the securities without registration or an applicable exemption. However, you can use this exemption for a public offering of your securities and investors will receive freely tradable securities under the following circumstances:
  • You register the offering exclusively in one or more states that require a publicly filed registration statement and delivery of a substantive disclosure document to investors;
  • You register and sell in a state that requires registration and disclosure delivery and also sell in a state without those requirements, so long as you deliver the disclosure documents mandated by the state in which you registered to all purchasers; or,
  • You sell exclusively according to state law exemptions that permit general solicitation and advertising, so long as you sell only to "accredited investors," a term we describe in more detail below in connection with Rule 505 and Rule 506 offerings.
Even if you make a private sale where there are no specific disclosure delivery requirements, you should take care to provide sufficient information to investors to avoid violating the antifraud provisions of the securities laws. This means that any information you provide to investors must be free from false or misleading statements. Similarly, you should not exclude any information if the omission makes what you do provide investors false or misleading.

Rule 505
Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, you may sell to an unlimited number of "accredited investors" and up to 35 other persons who do not need to satisfy the sophistication or wealth standards associated with other exemptions. Purchasers must buy for investment only, and not for resale. The issued securities are "restricted." Consequently, you must inform investors that they may not sell for at least a year without registering the transaction. You may not use general solicitation or advertising to sell the securities.
An "accredited investor" is:
  • a bank, insurance company, registered investment company, business development company, or small business investment company;
  • an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
  • a charitable organization, corporation or partnership with assets exceeding $5 million;
  • a director, executive officer, or general partner of the company selling the securities;
  • a business in which all the equity owners are accredited investors;
  • a natural person with a net worth of at least $1 million;
  • a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
  • a trust with assets of at least $5 million, not formed to acquire the securities offered, and whose purchases are directed by a sophisticated person.

It is up to you to decide what information you give to accredited investors, so long as it does not violate the antifraud prohibitions. But you must give non-accredited investors disclosure documents that generally are the same as those used in registered offerings. If you provide information to accredited investors, you must make this information available to the non-accredited investors as well. You must also be available to answer questions by prospective purchasers.

Here are some specifics about the financial statement requirements applicable to this type of offering:

  • Financial statements need to be certified by an independent public accountant;
  • If a company other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the company's balance sheet, to be dated within 120 days of the start of the offering, must be audited; and
  • Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish audited financial statements prepared under the federal income tax laws.
Rule 506
As we discussed earlier, Rule 506 is a "safe harbor" for the private offering exemption. If your company satisfies the following standards, you can be assured that you are within the Section 4(2) exemption:
  • You can raise an unlimited amount of capital;
  • You cannot use general solicitation or advertising to market the securities;
  • You can sell securities to an unlimited number of accredited investors (the same group we identified in the Rule 505 discussion) and up to 35 other purchasers. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated - that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment;
  • It is up to you to decide what information you give to accredited investors, so long as it does not violate the antifraud prohibitions. But you must give non-accredited investors disclosure documents that generally are the same as those used in registered offerings. If you provide information to accredited investors, you must make this information available to the non-accredited investors as well;
  • You must be available to answer questions by prospective purchasers;
  • Financial statement requirements are the same as for Rule 505; and
  • Purchasers receive "restricted" securities. Consequently, purchasers may not freely trade the securities in the secondary market after the offering.
E. Accredited Investor Exemption - Section 4(6)
Section 4(6) of the Securities Act exempts from registration offers and sales of securities to accredited investors when the total offering price is less than $5 million.

The definition of accredited investors is the same as that used in Regulation D. Like the exemptions in Rule 505 and 506, this exemption does not permit any form of advertising or public solicitation. There are no document delivery requirements. Of course, all transactions are subject to the antifraud provisions of the securities laws.

F. California Limited Offering Exemption - Rule 1001
SEC Rule 1001 provides an exemption from the registration requirements of the Securities Act for offers and sales of securities, in amounts of up to $5 million, that satisfy the conditions of §25102(n) of the California Corporations Code. This California law exempts from California state law registration offerings made by California companies to "qualified purchasers" whose characteristics are similar to, but not the same as, accredited investors under Regulation D. This exemption allows some methods of general solicitation prior to sales.

G. Exemption for Sales of Securities through Employee Benefit Plans - Rule 701
The SEC's Rule 701 exempts sales of securities if made to compensate employees. This exemption is available only to companies that are not subject to Exchange Act reporting requirements. You can sell at least $1,000,000 of securities under this exemption, no matter how small your company is. You can sell even more if you satisfy certain formulas based on your company's assets or on the number of its outstanding securities. If you sell more than $5 million in securities in a 12-month period, you need to provide limited disclosure documents to your employees. Employees receive "restricted securities" in these transactions and may not freely offer or sell them to the public.

Are There State Law Requirements in Addition to Federal Ones?
The federal government and state governments each have their own securities laws and regulations. If your company is selling securities, it must comply with federal and state securities laws. If a particular offering is exempt under the federal securities laws, that does not necessarily mean that it is exempt from any of the state laws.

Historically, most state legislatures have followed one of two approaches in regulating public offerings of securities, or a combination of the two approaches. Some states review small businesses' securities offerings to ensure that companies disclose to investors all information needed to make an informed investment decision. Other states also analyze public offerings using substantive standards to assure that the terms and structure of the offerings are fair to investors, in addition to the focus on disclosure.

To facilitate small business capital formation, the North American Securities Administrators Association, or NASAA, in conjunction with the American Bar Association, developed the Small Company Offering Registration, also known as SCOR. SCOR is a simplified "question and answer" registration form that companies also can use as the disclosure document for investors. SCOR was primarily designed for state registration of small business securities offerings conducted under the SEC's Rule 504, for sale of securities up to $1,000,000, discussed on page 20. Currently, over 45 states recognize SCOR. To assist small business issuers in completing the SCOR Form, NASAA has developed a detailed "Issuer's Manual."

In addition, a small company can use the SCOR Form, called Form U-7, to satisfy many of the filing requirements of the SEC's Regulation A exemption, for sales of securities of up to $5,000,000 (discussed on page 19), since the company may file it with the SEC as part of the Regulation A offering statement.

To assist small businesses offering in several states, many states coordinate SCOR or Regulation A filings through a program called regional review. Regional reviews are available in the New England, Mid-Atlantic, Midwest and Western regions.
Companies seeking additional information on SCOR, regional reviews or the "Issuer's Manual" should contact NASAA.
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