As readers of this blog will probably know, every offering of securities must be registered or exempt from registration. Because registering an offering of securities is an expensive and time-consuming enterprise, most small businesses seek to find an exemption from the registration requirements of the Securities Act of 1933, as amended (the "Securities Act").
In 1982, the Securities and Exchange Commission ("SEC") adopted Regulation D, which provided three rules exempting private placements of securities from the registration requirements of the Securities Act: Rule 504, Rule 505 and Rule 506.
Rule 504 provides an exemption from registration requirements for private companies offering not more than $1,000,000 of securities to an unlimited number of investors.
Rule 505 provides an exemption from registration requirements for companies offering not more than $5,000,000 of securities to not more than 35 investors and an unlimited number of accredited investors.
Rule 506 provides an exemption from registration requirements for companies offering any dollar amount of securities to not more than 35 investors, each of whom must be sophisticated, and an unlimited number of accredited investors.
So which rule get used the most in practice? Overwhelmingly, most issuers of securities in private placements under Regulation D choose to rely on Rule 506, selling strictly to accredited investors.
Rutherford B. Campbell, Jr., a professor at the University of Kentucky, conducted a study of 27,000 Form D's filed from 2008 to 2010 which was published in the August 2011 issue of The Business Lawyer. Professor Campbell found that 94% of all Regulation D offerings relied upon Rule 506, 1.6% relied upon Rule 505 and 4.4% relied upon Rule 504. 88.5% of the Regulation D offerings studied limited their offerings exclusively to accredited investors. Even among offerings of $1,000,000 or less (which would therefore qualify under Rule 504), 78.6% of the issuers chose to rely upon Rule 506 rather than Rule 504.
Professor Campbell attributed the popularity of Rule 506 to the exemption such offerings enjoy from state level blue sky regulations under the National Securities Markets Improvement Act of 1996 ("NSMIA"). I agree.