Release No. 33-6759

March 3, 1988

Regulation D Revisions

ACTION: Notice of Proposed Rulemaking

SUMMARY: The Commission is publishing for comment additional revisions to Regulation D. The regulation provides for three different exemptions from the registration requirements of the Securities Act of 1933 (the "Securities Act") for certain limited offerings of securities. The revisions proposed here involve additions to the "accredited investor" definition, a change in the requirements which are designed to reflect the "restricted" character of securities issued in a Regulation D transaction, and the deletion of the filing of a Form D as a condition to the Regulation D exemption. A new Rule 507 is proposed which would disqualify an issuer from the use of any of the Regulation D exemptions if it has been found to have violated Rule 503 which will still require the filing of a Form D no later than fifteen days after the first sale of securities. A new Rule 508 is also proposed which would provide that minor and isolated failures to comply with the requirements of Regulation D will not necessarily cause the loss of an exemption. In a companion action today, a number of revisions to the regulation have been finalized.

DATE: Comments must be received on or before May 13, 1988.

ADDRESS: Comment letters should refer to File No. S7-4-88 and be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. Comments will be available for public inspection and copying in the Commissions Public Reference Room at the above address.

FOR FURTHER INFORMATION CONTACT: Richard K. Wulff or Karen M. OBrien, (202) 272-2644, Office of Small Business Policy, Division of Corporation Finance, U.S. Securities and Exchange Commission, Washington, D.C. 20549.

SUPPLEMENTARY INFORMATION: The Commission is proposing several revisions to Regulation D, ¹ which exempts certain transactions from the registration requirements of the Securities Act. ² The revisions would add to the list of accredited investors certain plans established and maintained by the governments of the states or their political subdivisions as well as their agencies and instrumentalities, for the benefit of their employees. The list of steps previously required to be followed to assure the "restricted" status or non-transferable nature of securities issued in Regulation D is proposed to be no longer mandatory, although they would still demonstrate satisfactorily that reasonable care has been taken to assure that purchasers are not underwriters. The filing of Form D ³ as a condition to the Regulation D exemption is proposed to be eliminated. In lieu thereof, disqualifying provisions would be added which would prohibit an issuer, found to have violated the filing requirement, from using Regulation D in the future. Pursuant to another proposed provision, isolated and minor deviations from the requirements in Regulation D that occur despite a good faith and reasonable attempt to comply would not cause an issuer to lose an otherwise appropriate exemption from the registration provisions of the Securities Act.

Table of Contents

I. Proposed Revisions to Regulation D

Regulation D is the series of rules, Rules 501-506, which establish three separate exemptions from the registration requirements of the Securities Act. Last January, a number of proposals to amend the regulation were published for comment. ⁴ Today, the Commission adopted most of these proposals. ⁵ Several matters were raised in the public comments, especially in the area of whether or not a substantial or good faith compliance standard should apply to the regulation, which the Commission had asked about in the original notice of proposed rulemaking.

A. Accredited Investors

A number of commenters in the initial rulemaking from last January noted that states, municipalities, their instrumentalities and agencies, public universities and pension plans for their employees do not qualify for accreditation under section 4(6) of the Securities Act or Regulation D. ⁶ The Commission is proposing to amend Rules 215 and 501 to specifically include in the accredited lists, plans established and maintained by the governments of the states, their political subdivisions, as well as their agencies and instrumentalities for the benefit of their employees, when two conditions are met. The plan must have either a bank, savings and loan association, insurance company or registered investment adviser as its plan fiduciary. In addition, the plan must impose requirements governing fiduciary responsibility similar to those established by the Employee Retirement Income Security Act of 1974 ("ERISA"). ⁷ If such plans have the same kind of fiduciaries, plus the same standards governing investments as ERISA plans, there does not appear to be any reason to prohibit them from being accredited. Because such plans are exempt from coverage under ERISA, they do not presently qualify for accreditation under Rule 501(a)(1), Rule 215(a) or section 2(15)(i) of the Securities Act. The Commission understands, however, that many of the states institutional investor exemptions include pension and profit-sharing plans, without regard to employer identification. ⁸ Although the present rule provides that an ERISA plan also may be accredited if it has more than $5 million in assets, this alternative test is not proposed for the non-ERISA public plans, because unlike ERISA plans, they are not subject to specific regulations and governmental oversight.

Comment also is requested on the issue of including states, their political subdivisions, and agencies and instrumentalities in their own right, and state universities and colleges as accredited investors. Several of the states exempt sales to these kinds of investors. ⁹ After considering the comments, the Commission may decide to include one or more of these entities as accredited investors. Alternatively, it may be desirable to include provisions to assure that those included would have the requisite knowledge or sophistication to qualify as accredited investors. Commenters are specifically requested to address the need for conditions to such accreditation and the appropriate conditions, e.g., the presence of some specifically named fiduciary; or size of the fund. Comments with regard to other suitability-for-investment standards covering states and these other entities also are invited.

B. Substantial or Good-Faith Compliance

Many comments were received in response to the Commissions solicitation of comments about a standard of good faith compliance with Regulation D. Two revisions are being proposed to be made with what appear to be the principal areas of concern about technical noncompliance. In addition, a new rule is proposed which would provide that the Regulation D exemption for all sales is not lost by minor, isolated failures to comply with requirements in the regulation, where those deviations occur despite a good faith and reasonable attempt to comply. However, the exemption may be lost for a particular sale, if the deviation is significant with respect to that sale.

Comments are requested on each of the proposed revisions. In addition, commenters are requested to address whether a general substantial compliance standard is needed if the proposed revisions regarding the requirements designed to reflect the restricted character of the securities and the deletion of the filing of a Form D as a condition to the Regulation D exemption are adopted. Conversely, commenters should address the need for the latter two proposals if a general, substantial good faith standard is adopted.

(1) Demonstrating the "Restricted" Nature of the Securities

Rule 502(d) indicates that generally securities acquired in a Regulation D transaction have the same restricted status as securities acquired in a transaction under section 4(2) of the Securities Act and cannot be resold without registration or an exemption. In this connection, the issuer is reminded of its obligation to ensure that no distribution of these securities occurs without registration or appropriate exemption and that it take reasonable care to assure that purchasers are not underwriters under the Securities Act. Rule 502(d) lists certain actions which must be taken to reflect such reasonable care, including purchaser inquiries, written notifications to purchasers and legending securities. Inasmuch as compliance with Rule 502 is a condition to a Regulation D exemption, failure to take any of these steps makes the exemption unavailable. Commenters have frequently characterized this feature of the regulation as one particularly well-suited to be the subject of a substantial or good faith compliance standard.

Under the proposed amendment, the listing in Rule 502(d) would not be mandatory. Taking such actions, however, would be a satisfactory demonstration of the desired reasonable care. In this regard the burden would continue to be on the issuer to demonstrate that reasonable care had been taken to guard against an inappropriate distribution of "restricted" securities and to make certain that investors appreciate the restricted nature of the securities. ¹⁰

(2) Removing the Conditions to File Form D and New Rule 507

Rule 503 requires the filing of a notification on Form D within 15 days after the first sale of securities offered in reliance upon an exemption under Regulation D. Rules 504, 505 and 506 each condition the exemption upon compliance with Rule 503. Failure to make the filing in a timely manner makes the exemption unavailable. Commenters have frequently criticized this provision.

As proposed, the filing obligation under Rule 503 would continue but would no longer be a condition to the exemption. In order to provide an incentive for filing the Form D in a timely manner, the Commission is proposing new Rule 507, which would disqualify an issuer from the use of the Regulation D exemptions if it had been found to have violated Rule 503. Proposed Rule 507 has been patterned on Rule 252. ¹¹ The Commission would have the authority to waive disqualifications under proposed Rule 507 upon a showing of good cause by the issuer that the Regulation D exemption should not be denied. ¹²

(3) Isolated and minor deviations from requirements in Regulation D.

Proposed new Rule 508 is designed to provide additional flexibility in Regulation D so that minor, isolated failures in reasonable and good faith compliance efforts would not cause loss of the exemption from the registration requirements of the Securities Act for the entire offering. The exemption would be lost as to a specific sale affected by the violation, unless the violation is insignificant with respect to that sale. The rule sets forth several examples of violations that could fall within this provision. These examples are intended to highlight the minor nature of these deviations and the necessity for a good faith and reasonable effort to comply with the regulation in its entirety. Moreover, there are critical elements to a Regulation D exemption under the Securities Act, which establish the essence of the exemption; there cannot be any deviation from these requirements. Thus, for example, under Regulation D, limited offerings are contemplated and no general solicitation or advertising would be consistent with the exemptions provided. ¹³ The dollar limitations are critical elements of both the Rule 504 and Rule 505 exemptions. Use of either of these provisions by an investment company would be unacceptable; as would the use of Rule 504 by a reporting company. While neither this recitation nor the listing in Rule 508 is exhaustive, they do reflect the kinds of items which are encompassed and not encompassed by the rule.

Comments are requested as to whether the rule should provide, as proposed, that the exemption may be lost for certain offers and sales, if such offers and sales have been directly affected by the violation, even if the exemption is not lost for the offering as a whole. Comments also are requested as to whether defining insignificant to mean isolated and minor is a reasonable approach or whether any definition of the term is needed. Any other comments with respect to the scope of the proposed rule are also invited.

II. NASAA Cooperation

Regulation D serves as the basis for the uniform limited offering exemption ("ULOE"), ¹⁴ an official policy guideline of the North American Securities Administrators Association, Inc. ("NASAA"). ¹⁵ More than half of the states have adopted ULOE or an exemption substantially similar to it. The Commission and NASAA continue to encourage the remaining states to adopt ULOE.

The proposals made today by the Commission have been provided to representatives of the NASAA State-Federal Coordination Committee. The Commission appreciates the cooperation of NASAA and its Committee in considering these proposals as an addition to the ULOE policy statement.

III. Summary of Initial Regulatory Flexibility Analysis

The Commission has prepared an Initial Regulatory Flexibility Analysis in accordance with 5 U.S.C. 603 regarding these Regulation D proposals.

The analysis notes that the revisions to the "accredited investor" definition, and the elimination of the filing and certain other conditions to the exemptions are proposed as a result of public comment and the Commissions experience. The proposal of Rule 507 is designed as a complement to the elimination of the filing condition to encourage continued compliance with Rule 503. The proposal of Rule 508 is intended to provide that the exemption will not be lost if there are inadvertent minor and isolated failures to comply with the requirements. The objective of unifying exemptive schemes at the states and federal levels such as through a coordinated ULOE policy guideline and Regulation D is noted, since it can aid smaller issuers in the capital formation process. The proposals add no new reporting, recordkeeping or other compliance requirements and in fact may eliminate the need to provide certain information.

A copy of the Initial Regulatory Flexibility Analysis may be obtained from Twanna Young in the Office of Small Business Policy, Division of Corporation Finance, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W. Washington, D.C. 20549.

IV. Cost-Benefit Analysis

To assist in a full evaluation of the costs and benefits of these proposed revisions to Regulation D, the Commission seeks views and other data about these issues. The Commission believes the proposals if adopted would provide additional cost savings to issuers without compromising investor protection. The proposed revisions liberalizing certain conditions to the exemptions may produce savings through a reduction in the number of inadvertent late filings of Forms D causing a loss of the Regulation D exemption.

V. Statutory Basis and Text of the Proposed Amendments

The amendments to the Commissions rules are being proposed pursuant to sections 2(15), 3(b), 4(2), 4(6), 19(a) and 19(c) of the Securities Act.

List of Subjects in 17 CFR Part 230

Reporting and recordkeeping requirements, securities

TEXT OF PROPOSALS

In accordance with the foregoing, Title 17, Chapter II of the Code of Federal Regulations is proposed to be amended as follows:

(Arrows _ __ indicate proposed additions, brackets  indicate proposed deletions)

PART 230 -- GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

1. The authority citation for Part 230 continues to read, in part, as follows:

Authority: Sections 230.100 to 230.174 issued under Sec. 19,48 Stat. 85 as amended; 15 U.S.C. 77s, ***

2. Section 230.215 is amended by revising paragraph (a) as follows (the introductory text is republished):

§230.215 Accredited investor.

The term "accredited investor" as used in section 2(15)(ii) of the Securities Act of 1933 (15 U.S.C. 77b(15)(ii) shall include the following persons:

(a) Any savings and loan association or other institution specified in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; _ any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions for the benefit of its employees, if investment decisions are made by a plan fiduciary which is a bank, savings and loan association, insurance company, or registered investment adviser and the plan establishes fiduciary principles the same as or similar to those contained in sections 404-407 of Title I of the Employee Retirement Income Security Act of 1974; __ an employee benefit plan within the meaning of Title I of the Employee Retirement Income Security Act of 1974, if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such Act, which is a savings and loan association, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;

* * * * *

3. Section 230.501 is amended by revising the introductory text and paragraph (a)(1) as follows: §230.501 Definitions and terms used in Regulation D. As used in Regulation D (§§230.501 - __ 230.507 _), the following terms shall have the meaning indicated:

(a) * * *

(1) Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; insurance company as defined in section 2(13) of the Act; investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; _ any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions for the benefit of its employees, if investment decisions are made by a plan fiduciary which is a bank, savings and loan association, insurance company, or registered investment adviser and the plan establishes fiduciary principles the same as or similar to those contained in sections 404-407 of Title I of the Employee Retirement Income Security Act of 1974, __ employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such Act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;

* * * * *

4. Section 230.502 is amended by revising the introductory paragraph and paragraph (d) and adding a concluding paragraph as follows:

§230.502 General conditions to be met.

The following conditions shall be applicable to offers and sales made under Regulation D:

* * * *

(d) Limitations on resale. Except as provided in §230.504(b)(1), securities acquired in a transaction under Regulation D shall have the status of securities acquired in a transaction under section 4(2) of the Act and cannot be resold without registration under the Act or an exemption therefrom. The issuer shall exercise reasonable care to assure that the purchasers of the securities are not underwriters within the meaning of the Act, which reasonable care _ may be demonstrated by __ shall include, but not be limited to, the following:

(1)* * *

(2)* * *

(3)* * *

_ While taking these actions will establish the requisite reasonable care, they are not the exclusive method to demonstrate such care. Other actions by the issuer may satisfy this provision.__

5. Section 230.504 is amended by revising the section heading and paragraph (b)(1) as follows:

§230.504 Exemption for limited offerings and sales of securities not exceeding $1,000,000.

* * * * *

(b) Conditions to be met. -- (1) General Conditions. To qualify for exemption under this §230.504, offers and sales must satisfy the terms and conditions of §§230.501 _ and 230.502, __ through 230.503, except that the provisions of §§230.502(c) and (d) shall not apply to offers and sales of securities under this §230.504 that are made (i) exclusively in one or more states each of which provides for the registration of the securities and requires the delivery of a disclosure document before sale and that are made in accordance with those state provisions; or (ii) in one or more states which had no provision for the registration of the securities and the delivery of a disclosure document before sale, if the securities have been registered in at least one state which provides for such registration and delivery before sale, offers and sales are made in the state of registration in accordance which such state provisions, and such document is in fact delivered to all purchasers in the states which have no such procedure, before the sale of securities.

* * * * *

6. Section 230.505 is amended by revising paragraph (b)(1) as follows:

§230.505 Exemption for limited offers and sales of securities not exceeding $5,000,000.

* * * * *

(b) Conditions to be met -- (1) General Conditions. To qualify for exemption under this §230.506, offers and sales must satisfy all the terms and conditions of §230.505, offers and sales must satisfy all the terms and conditions of §§230.501 _ and 230.502. __ through 230.503.

7. Section 230.506 is amended by revising paragraph (b)(1) as follows:

§230.506 Exemption for limited offers and sales without regard to dollar amount of offering.

* * * * *

(b) Conditions to be met. -- (1) General Conditions. To qualify for exemption under this §230.501 _ and 230.502. __ through 230.503.

* * * * *

8. By adding a new section 230.507 to read as follows: §230.507 Disqualifying provision relating to exemptions under §§230.504, 230.505 and 230.506.

(a) No exemption under §§230.504, 230.505 or 230.506 shall be available for an issuer if such issuer, any of its predecessors or affiliates have been subject to any order, judgment, or decree of any court of competent jurisdiction temporarily, preliminarily or permanently enjoining such person for failure to comply with §230.503.

(b) Paragraph (a) of this section shall not apply if the Commission determines, upon a showing of good cause, that it is not necessary under the circumstances that the exemption be denied.

9. By adding a new section 230.508 to read as follows: §230.508 Isolated and minor deviations from requirements in Regulation D.

(a) A failure to comply with a condition or requirement of this Regulation D that is insignificant with respect to the offering as a whole will not result in the loss of the exemption under §§230.504, 230.505 or 230.506 if the issuer can show a good faith and reasonable attempt to comply with all provisions of the Regulation. No exemption would be available with respect to an offer or sale to a particular person unless the failure to comply was insignificant with respect to that offer or sale, as well as to the offering as a whole.

(b) For purposes of this rule, insignificant means an isolated and minor deviation from requirements.

Note: A failure to comply with a condition or requirement of Regulation D that is insignificant with respect to the offering as a whole may be illustrated as follows:

Example 1. Immaterial written information provided to an accredited investor is omitted from the description required to be delivered to non-accredited investors.

Example 2. A purchaser representative fails to disclose a relationship with the issuer prior to a purchasers acknowledgement of the representative but does so before the purchaser subscribes for an investment.

Example 3. One purchaser, as a result of a clerical error, fails to receive the information package prior to the completion of the sale.

By the Commission.

Jonathan G. Katz

Secretary

¹ 17 CFR 230.501-230.506. A number of revisions to the regulation also have been adopted today. Release No. 33-6758.

² 15 U.S.C. 77a et seq.

³ 17 CFR 239.500.

⁴ Release No. 33-6683 (January 16, 1987) 52 FR 3015.

⁵ Release No. 33-6758.

⁶ The Commission uses a uniform definition applicable to section 4(6) and Regulation D. Thus, Rule 501(a) is the same as section 2(15) of the Securities Act combined with Rule 215, 17 CFR 230.215. The proposals today would continue this uniformity by revising Rule 215.

⁷ 29 U.S.C. §§1104-1107.

⁸ Uniform Securities Act, Section 402(b)(8).

⁹E.g., California Administrative Code, Rule 260.104.14 1 CCH Blue Sky L. Rep. 11,806; Release No. 85-2, Michigan Corporation and Securities Bureau 1A CCH Blue Sky L. Rep. 32,602; South Dakota Codified Laws §47-31-88 3 CCH Blue Sky L. Rep. 52,229; Wisconsin Uniform Securities Law §551.23(8) (3 CCH Blue Sky L. Rep. 64,113).

¹⁰ The obligation to advise purchasers that they have restricted securities comes from Rule 10b-5, 17 CFR 240.10b-5. See Release No. 33-5226 (January 10, 1972) 37 FR 600.

¹¹ 17 CFR 230.252.

¹² A similar rule, Rule 703, was proposed in Release No. 33-6726 (July 30, 1987) in connection with a proposed exemption for certain employee compensation arrangements.

¹³ There is an exception for certain Rule 504 offerings.

¹⁴ CCH NASAA Rep. 6201 at 6101.

¹⁵ NASAA is an association of the securities commissioners of each of the 50 states, the District of Columbia, Puerto Rico and several of the Canadian provinces. An official policy guideline represents endorsement of a principle which NASAA believes has general application. NASAA has no power to enact legislation, promulgate regulations or otherwise bind the legislatures or administrative agencies of its members.