GETTING THE FINANCING: SECURITIES LAWS

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1 GETTING THE FINANCING: SECURITIES LAWS Chicago Bar Association 24th Annual Seminar How to Form An Illinois Business Entity Part 2 Adam S. Calisoff September 20, Edwards Wildman Palmer LLP & Edwards Wildman Palmer UK LLP OBTAINING FUNDS: "selling" to investors What do businesses sell? some type of EQUITY INTEREST, such as stock (common or preferred) for corporation, limited partnership interests for a limited partnership, membership interest for a limited liability company, etc.; OR some type of DEBT INSTRUMENT: bonds or notes. More likely than not, these equity interests and debt instruments will be considered "securities" as defined in federal and state securities laws. 2 1

2 Laws Governing Securities Securities Act of 1933 (Federal); Securities Exchange Act of 1934 (Federal); and Corresponding state securities laws (sometimes called "bluesky" laws). BASIC RULE: an issuer must "register" securities before offering or selling such securities under the relevant securities laws, unless the issuer can properly claim an exemption. 3 FEDERAL SECURITIES REGISTRATION VERY time consuming - average about eight weeks. VERY expensive - $400,000 - $600,000 is not uncommon. Persons involved in the process, such as the issuer's directors, managers, lawyers and accountants, are exposed to significant liability. Larger initial public offerings (IPOs), can cost several million dollars. The largest IPOs, like Visa's $20 billion offering in 2008, cost approximately $45 million. 4 2

3 STATE SECURITIES REGISTRATION Different from state to state, and multiple state registrations can be required. Require fees and expense. Persons involved in the process, such as the issuer's directors, managers, lawyers and accountants, are exposed to significant liability. If particular securities are registered under Federal Securities Laws, there is no need to register the same securities under State Securities Laws. 5 FEDERAL REGISTRATION PROCESS Governed by the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. Helpful to review: Regulation S-K - Standard Instructions for Filing Forms under the Securities Act of 1933, Securities Exchange Act of 1934, and Energy Policy and Conservation Act of 1975, 17 CFR The registration forms, which contain instructions for preparing registration statements. Some of the more common registration forms are: S-1 S-3 S-8 6 3

4 S-1 Registration Form default registration form. requires a very high level of disclosure. used to register securities for which no other form is authorized. Initial public offerings of an issuer's securities are done using this form. 7 S-3 Registration Form This registration form may be used by certain entities in connection with certain transactions and requires less disclosure than the Form S-1. Eligibility requirements for using the Form S-3 are as follows: Registrant (i) organized with principal operations in the U.S.; (ii) has a class of registered securities or is required to file reports pursuant to 15(d); and (iii) has timely filed all material reports for at least 12 months prior to filing the registration statement. Transaction (i) primary offerings by certain registrants (non-affiliates must hold securities with a market value equal to or greater than $75M); (ii) primary offering of non-convertible investment grade securities (at least one nationally recognized statistical rating organization has rated the securities of the issuer in a rating category that signifies investment grade); (iii) secondary offers (outstanding securities offered for the account of any person other than the issuer); (iv) rights offerings, dividend or interest reinvestment plans, and conversions of warrants or options; (v) offering of investment grade asset backed securities; or (vi) limited primary offerings by certain registrants. 8 4

5 S-8 Registration Form This registration form is used by registrants to register securities offered under any employee benefit plan to its employees or its subsidiaries or parents. 9 EDGAR System The Securities and Exchange Commission (the "SEC") oversees the federal registration of securities and the subsequent reporting requirements of registrants under the Securities Exchange Act of 1934, as amended. Filings with the SEC are typically done using the online EDGAR system, but paper submissions are allowed in certain circumstances. Information filed on EDGAR is available on the SEC's website

6 STATE REGISTRATION PROCESS Each state has its own registration process and forms. For example, to register securities in Illinois, see Illinois Form U-1 (Uniform Application to Register Securities). 11 AVOIDING REGISTRATION Fundamental concern of many clients is: "How can I avoid registration?" Answer: "Find an exemption." NOTE: Offering or selling securities without a registration statement when one is necessary, or improperly claiming an exemption can expose one to civil liabilities, criminal liabilities and rescission rights. 12 6

7 FEDERAL EXEMPTION: The issuance is not a "security." Not all investment instruments are "securities," as defined in 2(a)(1) of the 33 Act and by extensive case law. The U.S. Supreme Court held in S.E.C. v. W. J. Howey Co., 328 U.S. 293 (1946) that an investment is an "investment contract" and hence a "security" if it met all of these tests: A. Investment of money; B. In a common enterprise; C. With the expectation of profits; and D. Mostly from the efforts of others. 13 FEDERAL EXEMPTION: The issuance is an exempt security pursuant to 3 of the 1933 Act 3 provides a list of securities that are exempt from registration. Most of these will not be of interest to the attorney whose clients are regular, forprofit, small companies. However, one notable exemption is the "intrastate offering". "intrastate offering" under 3(a)(11): No filing is required to claim an exemption under this section. The "safe harbor" provision corresponding to this section is Rule 147. Requirements of an "intrastate offering" are as follows: A. securities must be offered and sold to persons residing in one state; B. issuer must be incorporated and doing business within that state; and C. no resales are permitted outside the state for 9 months after the last sale. 14 7

8 FEDERAL EXEMPTION: The seller is not required to register under 4(1) 4(1) states that a seller of a security is required to register that security under 5 only if the seller is an "issuer," "underwriter," or "dealer". These terms are defined in the statute. 15 FEDERAL EXEMPTION: The transaction is a private placement under 4(2) 4(2) provides that transactions by an issuer "not involving any public offering" are exempt from registration. This section covers both ends of a wide spectrum: at one end, very large private placements (such as the sale of all of a bond issue to a single investing insurance company), and at the other end, sales of securities to one's family and (perhaps) friends. Structuring a deal which would meet the requirements of the statute alone, and its case law, is difficult. The SEC has adopted various "safe harbor" rules, of which the current one is Rule 506, part of Regulation D. However, even if an issuer fails to qualify under Rule 506, it may still rely on 4(2) to conduct a private placement offering. 16 8

9 FEDERAL EXEMPTION: The transaction is a private placement under 4(2) (continued) Important factors to consider in determining the availability of the 4(2) exemption are as follows: A. Offeree qualification sophisticated in business and finance; able to bear the financial risk. B. Availability of information offering memorandum or access to information necessary to evaluate the prospective investment. C. Manner of offering no general advertising or solicitation. D. Absence of redistribution securities must come to rest in the hands of investors who do not intend to redistribute. 17 FEDERAL EXEMPTION: Regulation D Rules 504, 505 and 506 of Regulation D establish three categories of limited offerings that are exempted from 5 registration. As such, Regulation D is the happy hunting ground for companies with small issues seeking relief from the rigors of a federal registration. Regulation D has a long introduction and its own internal set of definitions. Rule 504: based upon the rule-making authority of 3(b), it permits issues up to $1,000,000 within a 12 month period to an unlimited number of purchasers. It is not available to " 12 reporting companies" (the 1934 Act). No formal disclosure is required and there are no suitability requirements for investors. 18 9

10 FEDERAL EXEMPTION: Regulation D (continued) Rule 505: also based upon the rule-making authority of 3(b), it is limited to issues up to $5,000,000 within a 12 month period to an unlimited number of accredited investors, but no more than 35 non- accredited investors. Some financial disclosure may be required (see Rule 502) and issuers are subject to disqualification provisions. Rule 506: based upon 4(2) - the private placement offering. Unlimited amount of securities may be issued to an unlimited number of accredited investors and up to 35 sophisticated persons. A nonaccredited investor qualifies as sophisticated if such investor has sufficient i knowledge and experience in financial i and business matters to make him capable of evaluating the merits and risks of the prospective investment. Some financial disclosure may be required (see Rule 502). 19 FEDERAL EXEMPTION: Regulation D Accredited Investor Definition Rule 501 of Regulation D defines "accredited investor" as any of the following: (i) certain financial institutions (i.e. banks, investment companies); (ii) any entity, including a trust, with total assets in excess of $5,000,000; (iii) directors, executive officers or general partners of the issuer; (iv) any individual with individual or joint net worth in excess of $1,000,000 (excluding the value of the primary residence of such individual); (v) any individual whose annual income for the past 2 years exceeded $200,000 ($300,000 with a spouse) and such individual reasonably expects to reach the same level of income in the current year; and (vi) any entity in which all equity owners are accredited investors

11 JOBS ACT Jumpstart Our Business Startups Act became the law April 5, Most fundamental change in regulation of private capital raises in decades Proposed new rules in descending order of certainty 21 GENERAL SOLICITATION Directions SEC to amend Rule 506 (proposed Rule 506(c)) to eliminate the prohibition on general solicitation. Accredited Investors - Non-Accredited Investors are not allowed under a 506(c) offering (compare with traditional Rule 506, which allows up to 35 non-accredited investors). Requirement that issuer take "reasonable steps" to verify that all purchasers are accredited investors. Objective determination of "reasonable steps" to verify, but likely more than simply reviewing the responses to the subscription agreements

12 GENERAL SOLICITATION (Continued) In addition to subscription agreements, possible "reasonable steps" depend on the type of investor, but may include: Reviewing public company compensation information for officers and directors; Reviewing W-2's or K-1's; Reviewing trade or industry publications discussing compensation; or Receiving third party verifications (method most likely used). Reasonable steps may also depend on the nature of the offering (how widespread was solicitation/advertisement?). 23 GENERAL SOLICITATION (Continued) Traditional Rule 506 offerings still available. New Form D so filers can elect traditional Rule 506 vs. new Rule 506(c) exemption. Preemption from state blue sky laws. SEC Proposing Release provides 30 day comment period, which ends September 28, 2012, following comment period SEC likely to adopt form of final Rule 506(c). UNTIL FINAL RULES ARE ADOPTED, NO GENERAL SOLICITATION 24 12

13 CROWDFUNDING JOBS ACT directs SEC to adopt by January 2013 an exemption that permits private companies to raise up to $1 million during any 12 month period through intermediaries using an internet based platform. $1 million includes amounts raised by means other than crowdfunding. Individual investors can contribute between $2,000 and $10,000, depending on the investor's income and net worth. Issuer must provide varying levels of financial information depending on the amount raised. Less than $100K: income tax returns and financial statements certified by CEO; More than $100K, but less than $500K: reviewed financial statements; and More than $500K (up to $1mil) audited financial statements. 25 CROWDFUNDING (Continued) Offering must be done only through a regulated internet based intermediary called a "Funding Portal" (these have not been established yet), but once established will be subject to additional restrictions. Significant logistical issues with large investor base (potential for up to 500 investors). UNTIL FINAL RULES ARE ADOPTED, NO CROWDFUNDING 26 13

14 SUPER REG A EXEMPTION Conditional Small Issues Exemption for public offerings. Currently $5 million, SEC directed to increase exemption similar to Reg A to $50 million during any 12 month period. Reg A did not restrict the types of investors who could participate in the offering. Offering statement on Form 1-A and Offering Circular required to be filed with SEC. 27 SUPER REG A EXEMPTION (Continued) No periodic reporting requirements. Unclear if new regulation will preempt state blue sky laws. Traditional Reg A did not. Therefore, given the $5 million limit, the SEC filing requirements and the state securities registration requirements, the traditional Reg A exemption was rarely used. UNTIL FINAL RULES (NOT LIKELY ANYTIME SOON) ARE ADOPTED, SUPER REG A EXEMPTION IS NOT AVAILABLE

15 FEDERAL EXEMPTION: Notes on Regulation D Securities sold under Regulation D are "restricted securities". Restricted securities may be sold under Rule 144. Rule 144 has several requirements including a holding period, which is one year for non-reporting companies. Issuers must file a Form D within 15 days of their first sale to claim any of the safe harbors discussed above. All Form D's must be filed electronically. 29 FEDERAL EXEMPTION: Notes on Regulation D Form D PROCESS To file an Electronic Form D, the company will need to obtain a CIK number and password for EDGAR by submitting a Form ID. This should be done at least 48 hours (2 business days) prior to filing to make sure you receive the required access information in time. The electronic Form D process is simple and the system guides you through the process

16 Electronic Form D Sections 1 and 2 31 Electronic Form D Section

17 Electronic Form D Section 4 33 Electronic Form D Section

18 Electronic Form D Sections 6, 7 and 8 35 Electronic Form D Sections 9, 10 and

19 Electronic Form D Section Electronic Form D Sections 13 and

20 Electronic Form D Sections 15 and Electronic Form D Signature and Submission 40 20

21 ILLINOIS STATE EXEMPTIONS Section 4G corresponds to Rule 504. Issuer must file an IL Form 4G "Report of Sale" or a copy of the SEC Form D no later than 12 months after the date of first sale to an Illinois resident. Section 4G may be relied upon in conjunction with Rule 504, but is not required to be used in conjunction with Rule 504. Section 4D corresponds to Rule 505. Issuer must file a copy of the Form D as filed with the SEC within 15 days after receiving consideration or delivery of a subscription agreement. Section 4D must be used in conjunction with Rule 505. Section 2a corresponds to Rule 506. Issuer must file a copy of the Form D as filed with the SEC. Section 2a must be used in conjunction with Rule 506. Other exemptions exist and can be found in the statute. 41 PRACTICE POINTS: Certificate Legends If your client is issuing restricted securities, the restrictions should be printed directly onto each and every security certificate issued. If the issuer fails to do so, other potential purchasers will not be on notice of the restricted nature of said securities. NOTE: Securities issued under Regulation D are restricted securities and require legends! 42 21

22 PRACTICE POINTS: Presentations to Investors Often companies will create presentations about the company or idea that detail the amount of money they are hoping to raise. Clear disclaimer language should be added to ALL materials and presentations that explicitly provide the materials DO NOT constitute an offer to sell securities or a solicitation regarding the purchase of securities. If the potential issuer fails to do so, they may violate the securities laws which prohibit the offer and sale of securities without meeting certain requirements. 43 PRACTICE POINTS: Subscription Agreements Pay particular attention to knowledge representations made by purchasers in subscription agreements and make sure they represent all the required information for any particular offering exemption your client is relying on. Specifically, at a minimum, purchasers should represent they have received sufficient information regarding the issuer, have made an independent investment decision regarding the issuer, and have not relied on any information other than the specific documents provided with the subscription agreement in making their investment determination

23 CHICAGO BAR ASSOCIATION Twenty-fourth Annual Seminar on HOW TO FORM AN ILLINOIS BUSINESS ENTITY PART 2 September 20, 2012 GETTING THE FINANCING: SECURITIES LAWS By Mr. Adam S. Calisoff Edwards Wildman Palmer LLP

24 I. INTRODUCTION. A. OBTAINING FUNDS: to start or grow a business, your client may want to sell to investors: 1. some type of equity interest, such as stock (common or preferred) for corporation, limited partnership interests for a limited partnership, membership interest for a limited liability company, etc.; OR 2. some type of debt instrument: bonds or notes. More likely than not, these equity interests and debt instruments will be considered securities as defined in federal and state securities laws. Laws governing Securities: A. Securities Act of 1933 (Federal); B. Securities Exchange Act of 1934 (Federal); and C. Corresponding state securities laws (sometimes called blue-sky laws) [Note: this outline primarily focuses on the federal laws.] B. BASIC RULE: an issuer must register securities before offering or selling such securities under the relevant securities laws, unless the issuer can properly claim an exemption. Offering or selling securities without a registration statement when one is necessary, or improperly claiming an exemption can expose one to civil liabilities, criminal liabilities and recession rights. The Federal registration process is: 1. VERY time consuming - average about eight weeks 2. VERY expensive - $400,000 - $600,000 is not uncommon 3. Persons involved in the process, such as the issuer s directors, managers, lawyers and accountants, are exposed to significant liability. State registration processes are: 1. Different from state to state, and multiple state registrations can be required 2. Require fees and expenses 3. Persons involved in the process, such as the issuer s directors, managers, lawyers and accountants, are exposed to significant liability. Thus, the fundamental concern of many clients is: How can I avoid registration? [Note: avoiding registration is discussed in Section III.] 2

25 II. REGISTRATION. A. FEDERAL REGISTRATION: is governed by the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. To begin learning about the process, it is helpful to review the following: 1. Regulation S-K - Standard Instructions for Filing Forms under the Securities Act of 1933, Securities Exchange Act of 1934, and Energy Policy and Conservation Act of 1975, 17 CFR The registration forms, which contain instructions for preparing registration statements. Some of the more common registration forms are below: A. Form S-1 This is the default registration form that requires a high level of disclosure and it is used to register securities for which no other form is authorized. Initial public offerings of an issuer s securities are done using this form. B. Form S-3 This registration form may be used by certain entities in connection with certain transaction. It requires less disclosure than the Form S-1. Eligibility requirements for using the Form S-3 are as follows: a. Registrant (i) organized with principal operations in the U.S.; (ii) has a class of registered securities or is required to file reports pursuant to 15(d); and (iii) has timely filed all material reports for at least 12 months prior to filing the registration statement. b. Transaction (i) primary offerings by certain registrants (non-affiliates must hold securities with a market value equal to or greater than $75M); (ii) primary offering of nonconvertible investment grade securities (at least one nationally recognized statistical rating organization has rated the securities of the issuer in a rating category that signifies investment grade); (iii) secondary offers (outstanding securities offered for the account of any person other than the issuer); (iv) rights offerings, dividend or interest reinvestment plans, and conversions of warrants or options; (v) offering of investment grade asset backed securities; or (vi) limited primary offerings by certain registrants. C. Form S-8 This registration form is used by registrants to register securities offered under any employee benefit plan to its employees or its subsidiaries or parents. The Securities and Exchange Commission (the SEC ) oversees the federal registration of securities and the subsequent reporting requirements of registrants under the Securities Exchange Act of 1934, as amended. Filings with the SEC are typically done 3

26 using the online EDGAR system, but paper submissions are allowed in certain circumstances. B. STATE REGISTRATION: Each state has its own registration process and forms. For example, to register securities in Illinois, see Illinois Form U-1 (Uniform Application to Register Securities). Securities that are registered under the Federal Registration system do not need to be registered in any state. III. AVOIDING REGISTRATION. A. FEDERAL EXEMPTIONS: As discussed above, if you client does not have to register the securities they sell under the federal securities laws because a proper exemption to federal registration exists, you can save your client time and money. Below are some of the more popular. 1. The issuance is not a security. Not all investment instruments are securities, as defined in 2(a)(1) of the 33 Act and by extensive case law. The U.S. Supreme Court held in S.E.C. v. W. J. Howey Co., 328 U.S. 293 (1946) that an investment is an investment contract and hence a security if it met all of these tests: A. Investment of money B. In a common enterprise C. With the expectation of profits D. Mostly from the efforts of others. 2. The issuance is an exempt security pursuant to 3 of the 1933 Act. 3 provides a list of securities that are exempt from registration. Most of these will not be of interest to the attorney whose clients are regular, for-profit, small companies. However, one notable exemption is the intrastate offering discussed next. 3. The transaction is an intrastate offering under 3(a)(11). No filing is required to claim an exemption under 3(a)(11). The safe harbor provision corresponding to this section is Rule 147. Requirements of an intrastate offering are as follows: A. securities must be offered and sold to persons residing in one state; B. issuer must be incorporated and doing business within that state; and C. no resales are permitted outside the state for 9 months after the last sale. 4. The seller is not required to register under 4(1). 4(1) states that a seller of a security is required to register that security under 5 only if the seller is an issuer, underwriter, or dealer. Other exempt transactions are provided in 4, including a notable exemption for private placements, which is discussed in detail below. 4

27 5. The transaction is a private placement. 4(2) provides that transactions by an issuer not involving any public offering are exempt from registration. This section covers both ends of a wide spectrum: at one end, very large private placements (such as the sale of all of a bond issue to a single investing insurance company), and at the other end, sales of securities to one s family and (perhaps) friends. Structuring a deal which would meet the requirements of the statute alone, and its case law, is difficult. The SEC has adopted various safe harbor rules, as part of Regulation D. However, even if an issuer fails to qualify under these rules, it may still rely on 4(2) to conduct a private placement offering. Important factors to consider in determining the availability of the 4(2) exemption are as follows: A. Offeree qualification sophisticated in business and finance; able to bear the financial risk. B. Availability of information offering memorandum or access to information necessary to evaluate the prospective investment. C. Manner of offering to be considered (i) Traditional Rule no general advertising or solicitation vs. (ii) once adopted JOBS ACT general advertising and solicitation D. Absence of redistribution securities must come to rest in the hands of investors who do not intend to redistribute. 6. Regulation D. Rules 504, 505 and 506 of Regulation D establish three categories of limited offerings that are exempted from 5 registration. As such, Regulation D is the happy hunting ground for companies with small issues seeking relief from the rigors of a federal registration. Regulation D has a long introduction and its own internal set of definitions. A. A term of great importance to understanding and utilizing Regulation D is accredited investor. Rule 501 of Regulation D defines accredited investor as any of the following: (i) certain financial institutions (ex. banks, investment companies); (ii) any entity, including a trust or charitable organization, with total assets in excess of $5,000,000; (iii) directors, executive officers or general partners of the issuer; (iv) any individual with individual or joint net worth in excess of $1,000,000, excluding the value of the primary residence of such individual; (v) any individual whose annual income for the past 2 years exceeded $200,000 ($300,000 with a spouse) and such individual reasonably expects to reach the same level of income in the current year; and (vi) any entity in which all equity owners are accredited investors. B. Rule 504: based upon the rule-making authority of 3(b), it permits issues up to $1,000,000 within a 12 month period to an unlimited number of purchasers. It is not available to 12 reporting companies (the 1934 Act). No formal disclosure is required and there are no suitability requirements for investors. 5

28 C. Rule 505: also based upon the rule-making authority of 3(b), it is limited to issues up to $5,000,000 within a 12 month period to an unlimited number of accredited investors, but no more than 35 nonaccredited investors. Some financial disclosure may be required (see Rule 502) and issuers are subject to disqualification provisions. D. Rule 506: based upon 4(2) - the private placement offering. Unlimited amount of securities may be issued to an unlimited number of accredited investors and up to 35 sophisticated persons. A nonaccredited investor qualifies as sophisticated if such investor has sufficient knowledge and experience in financial and business matters to make him capable of evaluating the merits and risks of the prospective investment. Some financial disclosure may be required (see Rule 502). E. JOBS ACT- Jumpstart Our Business Startups Act-became the law April 5, Most fundamental change in regulation of private capital raises in decades. Proposed new rules in descending order of certainty: F. GENERAL SOLICITATION- Directs SEC to amend Rule 506 (proposed Rule 506(c)) to eliminate the prohibition on general solicitation. (i) Accredited Investors - Non-Accredited Investors are not allowed under a 506(c) offering (compare with traditional Rule 506, which allows up to 35 non-accredited investors). (ii) Requirement that issuer take reasonable steps to verify that all purchasers are accredited investors. (iii) (iv) (v) Objective determination of reasonable steps to verify, but likely more than simply reviewing the responses to the subscription agreements. In addition to subscription agreements, possible reasonable steps depend on the type of investor, but may include: a. Reviewing public company compensation information for officers and directors; b. Reviewing W-2 s or K-1 s; c. Reviewing trade or industry publications discussing compensation; or d. Receiving third party verifications (method most likely used). Reasonable steps may also depend on the nature of the offering (how widespread was solicitation/advertisement?). a. Traditional Rule 506 offerings still available. 6

29 b. New Form D so filers can elect traditional Rule 506 vs. new Rule 506(c) exemption. c. Preemption from state blue sky laws. d. SEC proposing release provides 30 day comment period, which ends September 28, Following comment period SEC likely to adopt form of final Rule 506(c). e. UNTIL FINAL RULES ARE ADOPTED, NO GENERAL SOLICITATION G. CROWDFUNDING. JOBS ACT directs SEC to adopt by January 2013 an exemption that permits private companies to raise up to $1 million during any 12 month period through intermediaries using an internet based platform. (i) (ii) (iii) (iv) (v) $1 million includes amounts raised by means other than crowdfunding. Individual investors can contribute between $2,000 and $10,000, depending on the investor s income and net worth. Issuer must provide varying levels of financial information depending on the amount raised. a. Less than $100K: income tax returns and financial statements certified by CEO; b. More than $100K, but less than $500K: reviewed financial statements; and c. More than $500K (up to $1 million) audited financial statements. Offering must be done only through a regulated internet based intermediary called a Funding Portal (these have not been established yet), but once established will be subject to additional restrictions. Significant logistical issues with large investor base (potential for up to 500 investors). (vi) UNTIL FINAL RULES ARE ADOPTED, NO CROWDFUNDING H. SUPER REG A EXEMPTION. (i) (ii) (iii) Conditional Small Issues Exemption for public offerings. Currently $5 million, SEC directed to increase exemption similar to Reg A to $50 million during any 12 month period. Reg A did not restrict the types of investors who could participate in the offering. 7

30 (iv) (v) (vi) Offering statement on Form 1-A and Offering Circular required to be filed with SEC. No periodic reporting requirements. Unclear if new regulation will preempt state blue sky laws. Traditional Reg A did not. Therefore, given the $5 million limit, the SEC filing requirements and the state securities registration requirements, the traditional Reg A exemption was rarely used. (vii) UNTIL FINAL RULES (NOT LIKELY ANYTIME SOON) ARE ADOPTED, SUPER REG A EXEMPTION IS NOT AVAILABLE. Note: Securities sold under Regulation D are restricted securities. Restricted securities may be sold under Rule 144. Rule 144 has several requirements including a holding period, which is one year for non-reporting companies. Note: Issuers must file a Form D within 15 days of their first sale to claim any of the safe harbors discussed above. All Form D s must be filed electronically. B. ILLINOIS STATE EXEMPTIONS: Exemptions under Illinois securities laws corresponding to Regulation D: 1. Section 4G corresponds to Rule 504. Issuer must file an IL Form 4G Report of Sale or a copy of the SEC Form D no later than 12 months after the date of first sale to an Illinois resident. Section 4G may be relied upon in conjunction with Rule 504, but is not required to be used in conjunction with Rule Section 4D corresponds to Rule 505. Issuer must file a copy of the Form D as filed with the SEC within 15 days after receiving consideration or delivery of a subscription agreement. Section 4D must be used in conjunction with Rule Section 2a corresponds to Rule 506. Issuer must file a copy of the Form D as filed with the SEC. Section 2a must be used in conjunction with Rule Other exemptions exist and can be found in the statute. NOTE: Even if a Federal Exemption for the securities is found, it may be necessary to register the securities under a state statute, unless a state exemption is also found. 8

31 IV. PRACTICE POINTS. A. CERTIFICATE LEGENDS: If your client is issuing restricted securities, the restrictions should be printed directly onto each and every security certificate issued. If the issuer fails to do so, other potential purchasers will not be on notice of the restricted nature of said securities. B. PRESENTATIONS: Often companies will create presentations about the company or idea that detail the amount of money they are hoping to raise. Clear disclaimer language should be added to ALL materials and presentations that explicitly provide the materials DO NOT constitute an offer to sell securities or a solicitation regarding the purchase of securities. If the potential issuer fails to do so, they may violate the securities laws which prohibit the offer and sale of securities without meeting certain requirements. C. SUBSCRIPTION AGREEMENTS: Pay particular attention to knowledge representations made by purchasers in subscription agreements and make sure they represent all the required information for any particular offering exemption your client is relying on. Specifically, at a minimum, purchasers should represent they have received sufficient information regarding the issuer, have made an independent investment decision regarding the issuer, and have not relied on any information other than the specific documents provided with the subscription agreement in making their investment determination. D. RULE 506. If Proposed Rule 506(c) is adopted, you must carefully choose your 506 exemption. Will you have all accredited investors? Will you need general solicitation? Proposed Rule 506(c) does not impact ability to use traditional Rule 506 exemption. E. BACKGROUND CHECKS. Know your issuer. Exercise diligence in assisting with a capital raise. If possible, enlist third party services to run background checks concerning the executive officers of the issuer. 9

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