The SEC recently adopted final rules implementing significant changes to securities offerings done under Regulation A. Because of the greatly expanded scope of the offerings, they are referred to colloquially as Regulation A+ offerings. The SEC announced the final rules with a press release and fact sheet.
As most readers of this blog know, one of the key concepts in securities law compliance for private offerings is the definition of “accredited investor” in Regulation D. Although it is possible to include non-accredited investors in private offerings (e.g., Rule 506(b) permits offerings to up to 35 non-accredited investors), many issuers choose to limit their offerings to accredited investors only, which can simplify the offering from a documentation perspective.
One of the oddities of New York securities law is that a core legal requirement imposed by the state was preempted by federal law almost 20 years ago, and yet the requirement remains on the books. The National Securities Markets Improvement Act, or NSMIA, enacted by Congress in 1996, expressly restricts the level of regulation that states can impose on private offerings done in reliance on Rule 506 of Regulation D or Section 4(a)(2) of the Securities Act of 1933. Following NSMIA’s enactment, most states amended their “blue sky” securities regulations accordingly and basically only require the filing with the state of a copy of the federal Form D and the payment of a filing fee, which NSMIA permits. New York, in contrast, still requires a relatively involved form to be filed with the state under the Martin Act, requesting more information than is permitted by NSMIA.
In 2002, the Committee on Securities Regulation of the New York State Bar Association issued a position paper flatly stating that the requirements imposed by the Martin Act for these offerings are preempted by NSMIA. In the following years, many of my fellow corporate and securities attorneys accordingly advised their clients that no New York filing need be made for Rule 506 or Section 4(a)(2) offerings, on the theory that an enforcement action by New York is unlikely and, even if there is one, there would be a solid defense of federal preemption.
However, I’ve had a recent experience with a new client that may call for a reassessment of this approach. I was asked to prepare blue sky filings for a New York real estate developer that was the subject of an enforcement action by the Attorney General for failure to make the filings as required by the Martin Act. (I was not involved with this client in connection with the securities offerings that triggered the action; I was brought in after the Attorney General demanded that the filings be made.) Now, this client could have taken an aggressive approach and challenged the action on preemption grounds, but the client took a practical, cost-benefit approach to the issue and decided it was better just to comply with the filing requirement as requested by the state.
I don’t know if this case is part of a new and concerted effort on the part of the Attorney General to enforce these laws. There are some facts specific to this case that may set it apart – for example, the client allegedly engaged in some active public solicitation and advertising that are not permitted for private offerings of this type, and it may be that these activities put the developer on the state’s radar. Nevertheless, those conducting private offerings in New York might want to consider complying with the Martin Act filing requirements to avoid the later cost and headache of an enforcement action.
Under U.S. law, every sale of securities must either be registered or fall under an exemption from registration. This determination must be made both with respect to federal law and the law of the particular state (the “blue sky” law) in which the securities are being offered. In the bad old days – pre-1990s – each state had its own unique set of exemptions and filing requirements, meaning that a securities offering in multiple states required a significant amount of research and form preparation. In 1996, Congress passed the National Securities Markets Improvements Act (NSMIA), which effectively pre-empted most state regulation of “covered securities,” including securities sold under Rule 506. Post-NSMIA, states can’t do much more in these transactions than require the issuer to send in a copy of a Form D (as filed with the SEC) and pay a filing fee.
When startups are seeking to obtain seed capital through a friends and family financing, most of the time, those friends and family members make a direct cash investment either in their individual capacity or through a business entity that acts as an investment vehicle. Another option that is not widely known is for the investor to use tax-deferred retirement funds for the investment, via what’s known as a self-directed IRA. Essentially, IRA funds can be used for many investments other than the familiar publicly-traded stocks, bonds, mutual funds, ETFs, etc., and among the other permitted investments are private company securities. However, the investment must be made through a custodian who administers the process, executing transaction documents on behalf of the investor, etc. The custodians are not the familiar brokerages like Fidelity and Schwab, but others you probably haven’t heard of that specialize in this area. [Read more…]