What is an Exemption from Registration

What is an “exemption from registration?”

Regulation D’s Rule 504 and Rule 506 grant exemptions from registration if different requirements are met.

Rule 504

Rule 504 of Regulation D provides an exemption from registration for a 12-month period on the offer and sale of up to $5,000,000. Rule 504 permits general offerings and solicitations so long as they are restricted to accredited investors.

Companies that are not eligible to use the Rule 504 exemption include: companies that are already Exchange Act reported companies, investment companies, companies that “have no specific business plan or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company,” and companies with people disqualified under the “bad actor” disqualification provisions.

See: https://www.sec.gov/divisions/corpfin/guidance/rule504-issuer-small-entity-compliance.html

Rule 501(d)(1)(i)-(viii) lists the bad acts that fall under the “bad actor” disqualification rule. Only “bad acts” that have occurred on or after September 23, 2013 can destroy the exemption. Bad actors include:

  • Those who have been convicted within ten years of the sale of a felony or misdemeanor in connection with the purchase or sale of any security, involving any false filing with the SEC, or arising out of the business conduct of financial intermediaries.
  • Those subject to an SEC order at the time of sale entered under provisions related to investment companies, dealers, and brokers
  • Those subject to an SEC order at the time of sale that mandates the person to “cease and desist from committing or causing violations or future violations” of any intentional antifraud provision of the federal securities laws
  • Those suspended or expelled from membership in a registered national securities exchange or affiliated securities association for acts found to be incompatible with the just and equitable principles of trade

See: https://www.lexisnexis.com/legalnewsroom/banking/b/banking-finance/posts/rule-506-d-bad-actor-disqualifications-who-s-a-bad-actor-and-why-are-they-bad-part-i for more information


Rule 506

Rule 506 of Regulation D permits two distinct exemptions from registration when companies offer and sell securities. These two exemptions are split based on whether the issuer will engage in general solicitation to market securities.

The first exemption falls under Section 4(a)(2) of Rule 506(b). Section 4(a)(2) provides a “safe harbor” for companies that comply with certain requirements. In addition to a prohibition from using general solicitation to market securities, the requirements of the exemption include:

  • A company may sell its securities to an unlimited number of “accredited investors” and up to thirty-five other purchasers
  • A company’s information provided to accredited investors must not violate antifraud provisions of federal securities laws, and must not contain false or misleading statements
  • Companies must make themselves available to prospective purchasers to answer questions

The second exemption amends Section 4(a)(2) by permitting general solicitation. Companies remain exempt if participating investors are all accredited. For this exemption to apply, companies must take reasonable steps to confirm investors are in fact accredited. This amendment is stated in Rule 506(c).

Companies that comply with exemption requirements do not need to register their securities offering with the SEC. However, these companies must electronically file a “Form D” with the SEC after they initially sell securities. This form is a short notice that contains names and locations of promoters and executives and brief information about the offering.

See: https://www.sec.gov/fast-answers/answers-rule506htm.html

Why is it important to get an exemption from registration?

It is important to get an exemption from registration because by operating under Rule 506 exemptions, companies can raise unlimited capital from an unlimited number of accredited investors (and up to thirty-five (35) non-accredited investors).

Accredited investors are individuals with a joint net worth with their spouse of at least $1 million. Accredited investors also include individuals with income exceeding $200,000 in each of the two most recent years, or joint income with their spouse exceeding $300,000, plus “a reasonable expectation of reaching these income levels in the current year.” Companies with total assets in excess of $5 million are also accredited investors.

Being eligible for an exemption is important for getting help with funding from these types of accredited investors. About 90-95% of all private placements are conducted pursuant to Rule 506, and deals with accredited investors are generally private placements exempt from registration under Rule 506.

See: https://www.thesecuritiesedge.com/2012/09/securities-law-101-part-ii-avoiding-the-pitfalls-in-a-private-placement/

Also: Without an exemption from registration, the issuer, salespeople, officers, directors, and agents may be personally liable. If found liable, the investor can recover the principal, interest, and attorney fees.

See: https://www.equitynet.com/crowdfunding-terminology/general-solicitation