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J obs Act and Other Securities Law Essentials for Growing Companies

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JOBS ACT AND OTHER SECURITIES
LAW ESSENTIALS
FOR GROWING COMPANIES






STEVE QUINLIVAN
JILL RADLOFF
ETHAN MARK
DAVID JENSON

STINSON LEONARD STREET LLP

SEPTEMBER 2014


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TABLE OF CONTENTS
I. BASIC PRINCIPLES ......................................................................................................... 1
General Rule ....................................................................................................................... 1
What is a public offering? ................................................................................................... 1
What is a security? .............................................................................................................. 1
II. THE CLASSIC 4(A)(2) PRIVATE PLACEMENT ........................................................... 4
Do I Need a Private Placement Memorandum? .................................................................. 5
III. OTHER CONSIDERATIONS FOR PRIVATE PLACEMENTS ...................................... 5
Liability Standards .............................................................................................................. 5
Pitfalls for Issuers ............................................................................................................... 8
Pitfalls for Lawyers ............................................................................................................. 8
IV. PRIVATE OFFERINGS PURSUANT TO REGULATION D .......................................... 9
Overview ............................................................................................................................. 9
Offerings Pursuant to Rule 504......................................................................................... 11
Offerings Pursuant to Rule 505......................................................................................... 11
Offerings Pursuant to Rule 506(b) No General Solicitation Permitted ....................... 12
Offerings Pursuant to Rule 506(c)General Solicitation Permitted ............................... 13
Final SEC Rule Disqualifying Bad Actors From Rule 506 Offerings .............................. 20
V. PROPOSED REGULATION A+..................................................................................... 25
Investment Limitations ..................................................................................................... 25
Offering Statement ............................................................................................................ 25
Reporting Obligations ....................................................................................................... 26
Relationship with State Securities Laws ........................................................................... 26
VI. PROPOSED CROWDFUNDING RULES....................................................................... 26
Limitation on Capital Raised ............................................................................................ 26
Investment Limitation ....................................................................................................... 27
Transactions Conducted Through an Intermediary ........................................................... 28
Ineligible Issuers ............................................................................................................... 28
Prohibitions Applicable to the Issuer ................................................................................ 28
Form C and Filing Requirements ...................................................................................... 29
Required Disclosures of Offering Information ................................................................. 31
Discussion of Financial Condition and Financial Disclosures ......................................... 33
SEC Registration and FINRA Membership ...................................................................... 34
Financial Interests ............................................................................................................. 35
Fraud Reduction Measures ............................................................................................... 35

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Education Materials .......................................................................................................... 35
Investor Limits .................................................................................................................. 36
Investors Right to Cancel ................................................................................................ 36
Communication Channels ................................................................................................. 36
ATS/Secondary Market Transactions ............................................................................... 36
Registration ....................................................................................................................... 36
Exemption from Broker Dealer Registration .................................................................... 37
Restrictions on Resales ..................................................................................................... 37
Exemption from Section 12(g).......................................................................................... 37
FINRA Proposes Rules for Crowdfunding Portals ........................................................... 38
VII. OTHER PENDING J OBS ACT CHANGES ................................................................... 38
VIII. INTEGRATION ............................................................................................................... 40
IX. RULE 701 ......................................................................................................................... 43
X. EXCHANGE ACT REPORTING OBLIGATIONS ........................................................ 44
XI. USING FINDERS ............................................................................................................. 47
Who is a Broker? .............................................................................................................. 47
Examples of SEC No-Action Letters ................................................................................ 50
Examples of SEC Enforcement Action............................................................................. 51
Consequences of Hiring an Unregistered Broker ............................................................. 52
Blue Sky Issues ................................................................................................................. 53
Direct Regulation of Finders in Minnesota ....................................................................... 54
XII. TENDER OFFERS ........................................................................................................... 54
XIII. FOREIGN CORRUPT PRACTICES ACT ...................................................................... 55
XIV. WHISTLEBLOWERS ...................................................................................................... 56
XV. INVESTMENT COMPANIES ......................................................................................... 57
XVI. INVESTMENT ADVISERS ............................................................................................ 58


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I. BASIC PRINCIPLES
General Rule
Transactions in securities must either be registered with the SEC or exempt. A key
determining factor is whether a public offering is involved. Another key determining factor is
whether there is a sale of a security.
What is a public offering?
SEC v. Ralston Purina,
1
involved a suit by the Securities and Exchange Commission
(SEC) to enjoin a corporation from offering its common stock for sale to its employees without
complying with registration requirements of the Securities Act of 1933 (the Securities Act).
The Securities Act provides an exemption from its registration requirements for transactions by
an issuer not involving any public offering. The court found that an offering need not be open
to the whole world in order to qualify as a public offering for these purposes.
The purpose of the Securities Act is to protect investors by promoting full disclosure
of information that is necessary to making an informed investment decisions.
An offering to persons who are shown to be able to fend for themselves is a
transaction not involving any public offering within provision exempting such
offerings by an issuer from the registration requirements of the Act.
A private offering exemption is not dependent for its application on the number of
persons to whom the offer is made, and a quantity limit cannot be imposed.
Whether an issuance of corporate stock is exempt from registration requirements
depends on whether offerees have knowledge obviating the need for protection of the
Act and have access to the kind of information which registration would disclose.
What is a security?
The Securities Act provides The term security means any note, stock . . .bond . . .
investment contract . . . [and] fractional undivided interest in oil, gas, or other mineral rights . . .
Stock:
In Landreth Timber Co. v. Landreth,
2
the purchasers of all of the outstanding stock in a
lumber business brought a federal securities fraud action against the sellers. The court noted that:
Most instruments bearing traditional title such as stock are likely to be covered by the
definition of security contained in the federal securities laws.

1
346 U.S. 119 (1953).
2
471 U.S. 681 (1985).

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Those characteristics usually associated with common stock, thereby indicating that
such stock is a security within the meaning of federal securities laws, are the right to
receive dividends, negotiability, ability to be pledged or hypothecated, voting rights
in proportion to the number of shares owned, and the capacity to appreciate in value.
The sale of all of the outstanding stock in a lumber business involved the sale of a
security within the meaning of federal securities laws where, notwithstanding the fact
that the sale amounted to a sale of the entire business, it was likely that the investor
believed he or she was covered by federal securities laws.
Notes:
In Reeves et al. v. Ernst & Young,
3
the Supreme Court held in determining whether an
instrument denominated a note is a security, within the meaning of the securities laws, courts
should apply the family resemblance test. Under the family resemblance test, a note is
presumed to be a security, and the presumption may be rebutted only by showing that the note
bears a strong resemblance, determined by examining four specified factors, to one of a
judicially crafted list of categories of instruments that are not securities. If an instrument is not
sufficiently similar to a listed item, the court must decide whether another category should be
added by examining the same factors. The types of notes that the Court found were not
securities were:
a note delivered in consumer financing,
a note secured by a mortgage on a home,
a short-term note secured by a lien on a small business or some of its assets,
a note evidencing a character loan to a bank customer,
short-term notes secured by an assignment of accounts receivable, or
a note which simply formalizes an open-account debt incurred in the ordinary course
of business.
The four factors a court will consider in determining whether other types of transactions
are not notes are:
Motivations for the Transaction. Courts will assess the motivations that prompt a
reasonable seller and buyer to enter into a transaction. If the sellers purpose is to
raise money for the general use of a business enterprise or to finance substantial
investments and the buyer is interested primarily in the profit the note is expected to
generate, the instrument is likely to be a security. If the note is exchanged to
facilitate the purchase and sale of a minor asset or consumer good, to correct for the

3
494 U.S. 56 (1990).

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sellers cash-flow difficulties, or to advance some other commercial or consumer
purpose, on the other hand, the note is less sensibly described as a security.
The Plan of Distribution. Courts will examine the plan of distribution of the
instrument to determine whether it is an instrument in which there is common
trading for speculation or investment.
Reasonable Expectations of the Investing Public. A court will consider instruments to
be securities on the basis of public expectations that the instruments are securities,
even where an economic analysis of the circumstances of the particular transaction
might suggest that the instruments are not securities as used in that transaction.
Other Factors. A court will examine other factors render application of the Securities
Act unnecessary such as, for example, when an instruments risk is significantly
reduced because it is already subject to regulation pursuant to another regulatory
scheme.
Investment Contracts:
In SEC v. W.J. Howey Co.,
4
the Supreme Court stated an investment contract for
purposes of the Securities Act means a contract, transaction or scheme whereby a person: (i)
invests his money, (ii) in a common enterprise, and (iii) is led to expect profits solely from the
efforts of the promoter or a third party.
It is immaterial whether the shares in the enterprise are evidenced by formal certificates
or by nominal interests in the physical assets employed in the enterprise. The Court stated that
the test permits the fulfillment of the statutory purpose of compelling full and fair disclosure
relative to the issuance of the many types of instruments that in our commercial world fall
within the ordinary concept of a security. It embodies a flexible rather than a static principle,
one that is capable of adaptation to meet the countless and variable schemes devised by those
who seek the use of the money of others on the promise of profits.
Limited Liability Companies:
In some contexts, it is unclear whether interests in limited liability companies, or LLCs,
will be treated as securities for purposes of federal securities laws. However, where money is
raised from passive investors, it will often be found that securities are involved.
5

Under federal law, interests in limited liability companies are tested in the same manner
as general partnerships the investment contract test set forth in Howey is applied. One of the

4
328 U.S. 293 (1946).
5
See Wheaton, Current Status of Securities and Bankruptcy Issues, American Law InstituteAmerican Bar
Association Continuing Legal Education (2003). See also C. Bishop and D. Kleinberger, Limited Liability
CompaniesTax and Business Law, 11.01 et. seq. (1994 & Supp. 2006) for an extensive analysis of the topics
discussed herein.

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leading cases in this area is Williamson v. Tucker.
6
In Williamson, the court recognized that
although prior decisions had held that general partnership interests were generally not considered
investment contracts for the purposes of the federal securities laws, the mere fact that an
investment takes the form of a general partnership or joint venture does not inevitably insulate it
from the reach of the federal securities laws. The court found that if an investor general partner
irrevocably delegates his or her powers or is incapable of exercising them, or is so dependent on
a particular expertise of the promoter or managing partner that he or she has no reasonable
alternative to reliance on the managing promoter or manager, then the investment in the
partnership may be characterized as an investment contract. The court concluded that an investor
who claims that a general partnership interest is a security must overcome a presumption that the
general partnership interest is not an investment contract, but can establish the existence of a
security by showing that (i) the partnership agreement leaves so little power in the investor that
the arrangement is akin to a limited partnership, (ii) the investor is so inexperienced and
unknowledgeable in business affairs that he or she cannot intelligently exercise partnership
powers or (iii) the investor is so dependent on unique entrepreneurial or managerial abilities of
the promoter manager that he or she cannot replace the manager or exercise partnership powers.
If one wishes to avoid classification of an interest in a limited liability company as a
security, the organizational documents must be carefully drafted to provide investing members as
much power as possible. Consider an effective right to remove management, effective veto
rights, and majority and supermajority voting requirements. Also consider whether members can
bind the LLC. Note also that the greater the number of passive investors, the greater the
likelihood the investors are looking to the efforts of others under the Howey test, the case that
set the standard for the definition of an investment contract.
II. THE CLASSIC 4(A)(2) PRIVATE PLACEMENT
Ralston Purina
7
sets forth the basic ground rules for private placements
8
outside of a
statutory safe harbor:
The offering must be made to those able to fend for themselves; and
The offerees must have access to the kind of information required to be disclosed in
connection with a registered offering.
In addition to the sophistication and information requirements discussed in Ralston Purina, the
following are considered:

6
645 F. 2d 404 (5th Cir. 1981).
7
346 U.S. 119 (1953).
8
See Law of Private Placements (Non-Public Offerings) Not Entitled to Benefits of a Safe Harbors A Report
issued by the Committee of Federal Regulation of Securities, ABA Section of Business Law (the ABA Report),
The Business Lawyer, Vol. 66, November 2010 for a useful guide to the history and law of private placements.

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Manner of Offering:
It is clear that advertising, seminars and the like are not permitted (with the exception of
certain press releases by public companies meeting a safe harbor). It is often said that an issuer
(or placement agent) must have a pre-existing relationship with the offerees. While this is a
good rule to follow, it may not be necessary where institutional investors are involved. However,
if an offering is made to an indeterminate number of previously unknown offerees who may or
may not be financially sophisticated, that would raise serious questions.
9

Identity of Offerees:
The classical 4(a)(2) analysis, as stated by the SEC in now superseded Rule 146, required
that prior to making an offer, the issuer and any person acting on its behalf had to reasonably
believe that the offeree either had such knowledge and experience in financial and business
matters that he was capable of evaluating the merits and risks of the prospective investment or
was a person who was able to bear the economic risk of the investment.
Do I Need a Private Placement Memorandum?
There is no requirement that a private placement memorandum (a PPM) be generated
to perfect a common law private placement (compare Rule 506 where non-accredited investors
are included in an offering). Under Ralston Purina, it is access to information that matters.
Where only a handful of sophisticated investors are involved, not producing a PPM is often a
defensible choice. Where the number of offerees grows, providing a PPM is often a best
practice. It is desirable to be able to demonstrate the issuer and its business and attendant risks
were adequately explained.
III. OTHER CONSIDERATIONS FOR PRIVATE PLACEMENTS
Liability Standards
Valid Private PlacementsFederal Law:
Gustafson, et al., v. Alloyd Company, Inc.,
10
was an action brought by plaintiffs who
purchased substantially all of the corporations stock from sellers pursuant to a private sale
agreement. The plaintiffs sought rescission of the private sale agreement under Section 12(2) of
the Securities Act on the ground that the written sale agreement was a prospectus and
contained material misstatements. The Court held that although the term prospectus is defined
in Section 2(a)(10) of the Securities Act, in part, as any communication, written or by radio or
television, the term prospectus refers only to a document soliciting the public to acquire
securities.

9
See ABA Report.
10
513 U.S. 561 (1995).

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The effect of Gustafson is to take private placements out of Section 12 of the Securities
Act leaving Rule 10b-5 of the Securities Exchange Act as the primary basis of liability. The
effect is significant because an element of a Rule 10b-5 claim is scienter. Some of the
elements of Rule 10b-5 action include:
the defendant made a material misrepresentation or omission;
the defendant acted with scienter, or a wrongful state of mind, which means that
the defendant intended to make the material misrepresentation or omission, or acted
recklessly when making the misrepresentation or omission;
the material misrepresentation or omission was made in connection with the
purchase or sale of a security; and
the plaintiff relied upon the material misrepresentation or omission.
In Janus Capital Group, Inc., v. First Derivative Traders,
11
the plaintiff alleged that
J anus Capital Group, or J CG, and its wholly owned subsidiary, J anus Capital Management LLC,
or J CM, made false statements in mutual fund prospectuses filed by J anus Investment Fundfor
which J CM was the investment adviser. Although J CG created J anus Investment Fund, it was a
separate legal entity owned entirely by its mutual fund investors.
The case centered on whether J CG and J CM made the allegedly fraudulent statement in
the funds prospectus. The decision notes one makes a statement in connection with the
purchase or sale of securities by stating it. For purposes of Rule 10b-5, the maker of a
statement is the person or entity with ultimate authority over the statement, including its content
and whether and how to communicate it. Without control, a person or entity can merely suggest
what to say, and not make the statement in its own right. One who prepares or publishes a
statement on behalf of another is not its maker. This rule might best be exemplified by the
relationship between a speechwriter and a speaker. Even when a speechwriter drafts a speech, the
content is entirely within the control of the person who delivers it, and it is the speaker who takes
creditor blamefor what is ultimately said.
This holding in the case follows from Central Bank of Denver, N.A. v. First Interstate
Bank of Denver, N. A. (1994), in which the Court held that Rule 10b5s private right of action
does not include suits against aiders and abettors. Such suitsagainst entities that contribute
substantial assistance to the making of a statement but do not actually make itmay be
brought by the SEC, but not by private parties. According to the Court, a broader reading of
make, including persons or entities without ultimate control over the content of a statement,
would substantially undermine Central Bank. If persons or entities without control over the
content of a statement could be considered primary violators who made the statement, then
aiders and abettors would be almost nonexistent.

11
131 S. Ct. 2296 (2011).

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Many believe the Janus case eliminates most Rule 10b-5 liability for non-issuers that
help prepare disclosure documents. This includes investment banks, accountants and law firms.
Valid Private PlacementsState Law:
Minnesota law provides that a person is liable to the purchaser if the person sells a
security . . . by means of an untrue statement of a material fact or an omission to state a material
fact necessary in order to make the statement made, in light of the circumstances under which it
is made, not misleading, the purchaser not knowing the untruth or omission and the seller not
sustaining the burden of proof that the seller did not know and, in the exercise of reasonable
care, could not have known of the untruth or omission (emphasis added).
12
Note that the
Minnesota statute appears to change the standard from reckless to negligently in many
circumstances.
13

The same Minnesota statute provides for joint and several liability on the following
classes of persons (other than those who with the exercise of reasonable care could not have
known of the conduct):
direct or indirect controlling persons;
managing partners, executive officers, directors or individuals having a similar status;
individuals who are employees of or associated with persons who are liable and who
materially aided the conduct; and
broker-dealers, agents, investment advisers, or investment adviser representatives that
materially aid the conduct.
As a result, the Minnesota statute potentially undermines the protections of Janus under Federal
securities law.
Private PlacementsViolation of Section 5:
Section 12(a)(1) of the Securities Act provides a private right of action for offerings of
securities in violation of Section 5 of the Securities Act i.e. an offering intended to be an
exempt private offering that is invalid due to circumstances such as the purchase of securities by
non-accredited investors or the public offering of the securities. Damages under Section 5 are a
refund of the purchase price of the security in most circumstances. No causal connection to a
loss is required.
Since no causal connection is required, everyone who purchases in a bad private
placement can sue for a refund of the purchase pricei.e. everyone gets their money back.

12
MINN. STAT. 80A.76(b).
13
See Trooien v. Mansour, 608 F. 3d 1020 (8
th
Cir. 2010).

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Issues can arise as to what constitutes the extent of the private placement. Prior sales may be
integrated into one deemed offering increasing liability.
14

Pitfalls for Issuers
Some common pitfalls for issuers encountered in private placements are:
Selling Securities for Too High of a Value: Down rounds are emotional, especially
where friends and family see lost value.
Thinking Its Easy: Raising money is difficult and many are unable to complete an
offering.
Failure to Raise Enough Money: Failure to fund foreseeable needs results in possible
business failure, management distraction of continually raising money and increases
the likelihood of a down round.
Too Many Shareholders: Most small businesses do not have the resources or desire to
perform an investor relations function for numerous shareholders. In addition, a
splintered shareholder base may make it difficult to complete major corporate
transactions such as a merger or a sale of the business.
Failure to Keep Records: Complete and accurate shareholder records are essential for
the sale of a business. All transfers must be documented with hopefully evidence of
cancelled stock certificates. In addition, issuers will have to prove that all issuances
were exempt under the securities act.
Failure to Maintain D&O Insurance: Directors and officers liability insurance can
soften the blow if securities issuances are challenged.
Failure to Have Audited Financial Statements: The absence of audited financial
statements can cause difficulty in later rounds.
Pitfalls for Lawyers
Failure to Recognize Risk: A high proportion of start-up businesses fail, leading in
some cases for a search for deep pockets. Client acceptance procedures should
recognize this.
Unachievable Business Plans and Inexperienced Management: Unrealistic business
plans and inexperienced management leads to increased risks.
Participation in Offering: Ideally, lawyers should not make any statements about the
quality or nature of the investment. Lawyers should just collect checks and

14
See Rule 502(a) for SEC guidance on the integration analysis.

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subscription agreements. Avoid the use of firm names on mailings and
correspondence.
IV. PRIVATE OFFERINGS PURSUANT TO REGULATION D
Overview
Generally, sales of securities must be registered under the Securities Act, unless an
exemption from registration applies. Rules 501 through 508 under the Securities Act, which are
known as Regulation D, contain requirements relating to several different methods of conducting
sales of exempt securities. Compliance with Regulation D is not a requirement for a valid
private offering, nor is the election to attempt to comply with Regulation D an exclusive election;
for example, an issuer that attempts to comply with Rule 506(b) in a private offering does not
prevent an issuer from also claiming that the offering is exempt under Section 4(a)(2) of the
Securities Act, which contains a general exemption for transactions not involving any public
offering. However, compliance with Regulation D is attractive to issuers because it provides
specific steps the issuer can take to ensure a valid exemption.
Much of Regulation D is premised on the notion that certain individuals, termed
accredited investors, possess enough business sophistication, and have enough financial assets,
that they do not require the full protections of the securities laws and are able to withstand the
loss of their investment. An accredited investor is an investor that falls into one of eight
categories set forth in Rule 501(a), including a bank, a private business development company
under the Investment Advisers Act of 1940, a tax exempt organization with at least $5 million in
assets, and certain natural persons who have a net worth of at least $1 million, or who had an
annual income of at least $200,000 individually, or at least $300,000 together with a spouse, in
each of the last two years. In the past, a person could count the value of a primary residence
towards the $1 million net worth threshold. However, Section 413(a) of the Dodd-Frank Act
provided that the value of a persons primary residence can no longer be included as an asset for
purposes of calculating net worth, and debt secured by a primary residence must be counted as a
liability to the extent it exceeds the current fair market value of the residence.
There are four main types of offerings that are exempt under Regulation D, described in
Rule 504, Rule 505, or Rule 506(b), and Rule 506(c). Regulation D imposes different
requirements on the issuer with respect to each type of offering, but there are several issues that
are common to Regulation D offerings in general.
Integration:
With respect to a Regulation D offering, there is a window of six months prior to the
commencement of the offering and six months after the conclusion of the offering during which
other sales of securities may be considered integrated with the offering for purposes of
Regulation D. In other words, a sale of securities not in compliance with Regulation D three
months after the completion of an otherwise valid Regulation D offering could jeopardize the
entire offering if the subsequent sale is considered integrated. The SEC uses a five factor test to
determine whether offerings should be integrated: (i) whether the sales are part of a single plan
of financing; (ii) whether the sales involve issuance of the same class of securities; (iii) whether

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the sales have been made at or about the same time; (iv) whether the same type of consideration
is being received; and (v) whether the sales are made for the same general purpose.
Disclosures to Non-Accredited Investors:
If securities are offered or sold to non-accredited investors where permitted under
Regulation D, additional disclosure requirements apply to the materials provided to the non-
accredited investors. While the issuer can exercise a fair degree of control over the disclosures
it makes to accredited investors (provided it complies with anti-fraud provisions), the materials
that it must provide to non-accredited investors are generally equivalent to materials that must be
provided in connection with a public offering. As a result, an offering that includes non-
accredited investors can often be more expensive, time consuming, and burdensome to the issuer
than an offering solely to accredited investors.
Ban on Advertising and General Solicitation:
Except with respect to offerings under Rule 506(c), the offering cannot utilize any
advertising or general solicitation, including advertisements in newspapers, magazines, or any
other media that is distributed to an un-screened audience. Likewise, the offering cannot include
seminars or presentations that are open to the public at large.
Restrictions on Resale:
Securities purchased in a Regulation D offering are restricted securities within the
meaning of the Securities Act, which means that they may not be resold other than pursuant to
registration under the Securities Act or an exemption from such registration. The issuer is also
obligated to take reasonable steps to ensure that purchasers in a Regulation D offering are not
underwriters. An issuer can demonstrate it has taken reasonable steps to this end by: (i)
conducting a reasonably inquiry into whether a purchaser is purchasing for his own account or
for others; (ii) providing disclosure to investors that the securities are restricted securities and
cannot be resold other than pursuant to registration, or an exemption from registration, under the
Securities Act; and (iii) placing a legend on each certificate representing the securities that sets
forth the restrictions on transferability.
Filing Form D:
Rule 503 of Regulation D requires that in connection with an offering in reliance on Rule
504, Rule 505, or Rule 506, the issuer must complete and file a notice of sales on Form D with
the SEC within 15 days of the first sale of securities in the offering.
15
Form D may only be filed
online through the SECs EDGAR system, which requires issuers to apply for and obtain access
codes prior to making a Form D filing. Questions often arise as to the manner of calculating the
date of first sale with respect to an offering in which proceeds are held in escrow and no

15
In connection with the adoption of new Rule 506(c), discussed below, the SEC has proposed amendments to
Form D that would require the document to be filed at least 15 days in advance of the date of a general solicitation
with respect to Rule 506(c) offerings.

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subscription is accepted until a minimum level of aggregate proceeds is achieved. The SECs
view is that the date of first sale is the date the first investor is irrevocably contractually
committed to invest, which could vary depending on the terms of the subscription agreement
utilized in the offering.
16
With respect to an offering in which proceeds are held in escrow until
a minimum level of aggregate proceeds is achieved, the SEC interprets the date of first sale as
the date proceeds are first received into escrow.
17

State Blue Sky Filings:
Offerings conducted pursuant to Rule 506 implicate state blue sky law notice filing
requirements. As a result of adoption of the National Securities Markets Improvement Act of
1996, Rule 506 offerings are not subject to state registration requirements. However, this federal
preemption does not apply to Rule 504 or Rule 505 offerings, or to offerings exempt from
federal registration under Section 4(a)(2) of the Securities Act that do not comply with Rule 506.
While state registration requirements are preempted for Rule 506 offerings, states are still
allowed to impose notice filing requirements and require filing fees in connection with Rule 506
offerings, and most states have adopted such requirements, known as blue sky laws. State blue
sky laws typically require the issuer to pay an administrative fee and to file with the applicable
state a copy of the Form D for the offering and a cover letter that may require disclosure of other
offering information, such as the number of purchasers in the offering residing in the applicable
state. Blue sky filings add to the administrative expense of an offering, because each state has its
own approach to the filings. In Minnesota, a combination of statutes, administrative rules, and
interpretive materials provide that an issuer must file a copy of Form D with the Minnesota
Department of Commerce, pay a $300 filing fee, and indicate by letter the number of purchasers
in the offering and the aggregate amount of securities sold.
Offerings Pursuant to Rule 504
Rule 504 provides an exemption from registration for offers and sales of up to $1 million
in securities in any 12 month period, provided that the issuer is not a reporting company under
the Exchange Act, an investment company, or a blank check company. In addition, in certain
circumstances (generally if an issuer complies with state law public-offering type requirements)
the securities sold in a Rule 504 offering will not be restricted securities and the ban on general
advertising and solicitation in Rule 502(c) will not apply to the offering.
Offerings Pursuant to Rule 505
Rule 505 provides an exemption from registration for issuers (other than investment
companies) that offer and sell up to $5 million in securities in any 12 month period. Sales may
be made to an unlimited number of accredited investors and up to 35 non-accredited investors.
In addition to the typical Regulation D requirements described above, this exemption is not

16
See Securities Act Rules, Compliance and Disclosure Interpretations, 257.02, available at
http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm.
17
See Securities Act Rules, Compliance and Disclosure Interpretations, 257.05, available at
http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm.

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available for issuers who are subject to the bad actor disqualifications set forth in Rule 262 of
Regulation A. The bad actor disqualifications in Rule 262 are quite complicated and apply to a
number of different types of actors with respect to a number of different types of events with
varying look-back periods. Generally speaking, with respect to issuers, disqualifying events
include having been convicted of during the last five years, or being the subject of orders or
investigations within the last five years relating to, securities fraud (broadly defined), or having
filed a registration statement that is subject to an ongoing examination under Section 8 of the
Securities Act.
Offerings Pursuant to Rule 506(b) No General Solicitation Permitted
Historically, Rule 506 presented one type of offering exemption which required, among
other things, that there be no general solicitation and advertising in connection with the offering.
As we discuss in the next section, the SEC has recently bifurcated Rule 506 into two separate
exemptions. New Rule 506(c) now permits the use of general solicitation and advertising in
connection with private offerings (discussed in more detail below). Traditional Rule 506
offerings that do not make use of general solicitation and advertising can still be conducted as
before in reliance on Rule 506(b).
Rule 506(b) allows an issuer to sell an unlimited aggregate amount of securities to an
unlimited number of purchasers who are accredited investors and up to 35 purchasers who are
not accredited investors but who meet a certain threshold of investment sophistication. Rule 506
offerings accounted for an estimated $895 billion in capital raised in the U.S. in 2011, compared
with $984 billion raised through registered offerings.
18

If non-accredited investors are included in the offering, disclosures similar to those
required in public offerings must be made to the non-accredited investors, increasing the expense
and administrative burden of conducting the offering. While Rule 505 places no additional
requirements on non-accredited investors who participate in the offering, non-accredited
investors in a Rule 506(b) offering must, either alone or with a purchaser representative, have
such knowledge and experience in financial and business matters that he is capable of
evaluating the merits and risks of the prospective investment. In other words, some level of due
diligence on the part of the issuer is required with respect to non-accredited investors in Rule 506
offerings. This could take the form of a questionnaire that the investor fills out describing their
financial position and business sophistication.
The continued availability of existing Rule 506(b) will be important for those issuers that
either do not wish to engage in general solicitation in their Rule 506 offerings (and become
subject to the requirement to take reasonable steps to verify the accredited investor status of
purchasers) or wish to sell privately to non-accredited investors who meet Rule 506(b)s
sophistication requirements. For example, while offerings under Rule 506(c) will may require
issuers to engage in a range of steps to verify accredited investor status, the traditional method of

18
Securities Act Release No. 9354, Eliminating the Prohibition Against General Solicitation and General
Advertising in Rule 506 and Rule 144A Offerings, August 29, 2012.

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asking investors to self-certify that they meet the accredited investor definition by checking a
box will continue to satisfy the requirements of Rule 506(b). Traditional Rule 506(b) offerings
are also beneficial to investors with whom an issuer has a pre-existing substantive relationship.
One way in which Rule 506(b) offerings will change as a result of recent SEC rule
making is that offerings under Rule 506(b) are now subject to disqualification or disclosure rules
under the bad actor provisions discussed below.
Offerings Pursuant to Rule 506(c)General Solicitation Permitted
The SEC has adopted final rules eliminating the ban on general solicitation and
advertising in Rule 506 offerings as required by the J OBS Act. The changes are mostly
embodied in new Rule 506(c). The relationship between Rule 506(b) and new Rule 506(c) is
such that an issuer could conceivably transition an ongoing Rule 506(b) offering to a Rule 506(c)
offering to take advantage of general solicitation. The key question is whether all of the
requirements of Rule 506(c) are met with respect to all sales in the offering including sales
made prior to the determination to transition to a Rule 506(c) offering. This same concept
applies in the case of an issuer that began a Rule 506 offering before new Rule 506(c) went
effective in September and wants to transition to a generally solicited offering. On the other
hand, if an issuer has begun a Rule 506(c) offering and has engaged in advertising or general
solicitation, the issuer is unable to transition the offering to a Rule 506(b) offering; the use of
advertising or general solicitation would make compliance with the requirements of Rule 506(b)
impossible. Compliance with state blue sky laws must also be considered in connection with
Rule 506(c) offerings. Blue sky notice filings are typically required with respect to any sales or
offers of sales made in a particular state. If general solicitation and advertising is being utilized,
it may be difficult to track when offers have made their way into a particular state.
Definition of General Solicitation and Advertising:
Rule 506(c) does not itself change the existing definition of what constitutes general
solicitation and general advertising. Although those terms are not defined in Regulation D,
Rule 502(c) does provide examples of general solicitation and general advertising, including
advertisements published in newspapers and magazines, communications broadcast over
television and radio, and seminars where attendees have been invited by general solicitation or
general advertising. By interpretation, the SEC has confirmed that other uses of publicly
available media, such as unrestricted websites, also constitute general solicitation and general
advertising, but that presentations commonly known as venture fairs or demo days do not
constitute general solicitation or advertising..
General Requirements:
Under new Rule 506(c), issuers can offer securities through means of general solicitation,
provided that they satisfy all of the conditions of the exemption. These conditions are:
all terms and conditions of Rule 501, Rule 502(a), and Rule 502(d) must be satisfied.
Rule 501 consists mostly of definitions, Rule 502(a) addresses integration with other
offerings and Rule 502(d) requires issuers to take reasonable steps to prevent

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purchasers from further distributions of securities so that they are not classified as
underwriters;
all purchasers of securities must be accredited investors; and
the issuer must take reasonable steps to verify that the purchasers of the securities are
accredited investors.
Principles-Based Approach to Verifying Accredited Investor Status:
Under Rule 506(c), issuers are required to take reasonable steps to verify the accredited
investor status of purchasers. Whether the steps taken are reasonable will be an objective
determination by the issuer (or those acting on its behalf), in the context of the particular facts
and circumstances of each purchaser and transaction. The SEC calls this a principles-based
approach, and has indicated that it does not intend to provide guidance or approval on a case by
case basis for issuers. The SEC is unconcerned with the actual circumstances of a purchaser; the
rule relates only to the steps taken by an issuer, the conclusion reached by the issuer, and
whether the steps taken and conclusion reached were reasonable. For example, if a purchaser
turns out to not, in fact, be an accredited investor, the Rule 506(c) exemption is still valid as long
as the issuer made a reasonable inquiry and formed a reasonable belief as to the purchasers
accredited status within the meaning of Rule 506(c). Conversely, if an issuer fails to make the
necessary inquiry, the Rule 506(c) exemption will not be available to the issuer, even if it turns
out that each purchaser is in fact an accredited investor.
The SEC has indicated that the steps required to be taken by an issuer should be
appropriately scaled depending on the likelihood that a purchaser is an accredited investor.
Among the factors that issuers should consider relating to the likelihood that a prospective
purchaser is an accredited investor are:
the nature of the purchaser and the type of accredited investor that the purchaser
claims to be;
the amount and type of information that the issuer has about the purchaser; and
the nature of the offering, such as the manner in which the purchaser was solicited to
participate in the offering, and the terms of the offering, such as a minimum
investment amount.
These factors are interconnected and are intended to help guide an issuer in assessing the
reasonable likelihood that a purchaser is an accredited investor which would, in turn, affect the
types of steps that would be reasonable to take to verify a purchasers accredited investor status.
After consideration of the facts and circumstances of the purchaser and of the transaction, the
more likely it appears that a purchaser qualifies as an accredited investor, the fewer steps the
issuer would have to take to verify accredited investor status, and vice versa.
While intended by the SEC to be flexible and adaptable, the principles-based approach to
verifying accredited investor status is also a source of uncertainty for issuers. In an attempt to

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provide some additional guidance to issuers, the Securities Industry and Financial Markets
Association (SIFMA) released a memo on J une 23, 2014, outlining several specific methods for
verifying accredited investor status that SIFMA believes would satisfy the principles-based
approach. For registered broker-dealers and investment advisers seeking to verify the accredited
investor status of a natural person the SIFMA memo provides two proposed methods one based
on the account balance of the investor and one based on the amount being invested in the
offering that SIFMA believes would satisfy the principles-based approach. Of course, the
SIFMA memo does not constitute SEC guidance, but it does have the support of a number of
major law firms and may be a useful tool in seeking to satisfy an issuers obligation to take
reasonable steps to verify accredited investor status outside of the Rule 506(c) safe harbors. The
SIFMA memo also contains an example questionnaire for use in verifying accredited investor
status of natural persons and an example of a written verification that could be provided to an
issuer by a broker-dealer, investment adviser, or law firm certifying that a purchaser is an
accredited investor for purposes of the written third party confirmation safe harbor.
Nature of the Purchaser: Rule 501(a) sets forth different categories of
accredited investors, such as broker-dealers, investment companies, employee benefit plans
established by state governmental entities, and tax exempt organizations. Issuers should
recognize that the steps that will be reasonable to verify whether a purchaser is an accredited
investor will vary depending on the type of accredited investor that the purchaser claims to be.
For example, the steps that may be reasonable to verify that an entity is an accredited investor by
virtue of being a registered broker-dealer such as by going to FINRAs BrokerCheck website
will necessarily differ from the steps that may be reasonable to verify whether a natural person is
an accredited investor.
Information about the Purchaser: The amount and type of information that
an issuer has about a purchaser can also be a significant factor in determining what additional
steps would be reasonable to take to verify the purchasers accredited investor status. The more
information an issuer has indicating that a prospective purchaser is an accredited investor, the
fewer steps it may have to take, and vice versa. Examples of the types of information that issuers
could review or rely upon any of which might, depending on the circumstances, in and of
themselves constitute reasonable steps to verify a purchasers accredited investor status
include, without limitation:
publicly available information in filings with a federal, state or local regulatory body
for example, if the purchaser claims to be an IRC Section 501(c)(3) organization
with $5 million in assets, and the organizations Form 990 series return filed with the
Internal Revenue Service discloses the organizations total assets;
third-party information that provides reasonably reliable evidence that a person falls
within one of the enumerated categories in the accredited investor definition for
example, without limitation:
o the purchaser is a natural person and provides copies of pay stubs for the two
most recent years and the current year; or

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o verification of a persons status as an accredited investor by a third party,
provided that the issuer has a reasonable basis to rely on such third-party
verification.
Nature and Terms of the Offering: The nature of the offering such as the
means through which the issuer publicly solicits purchasers may be relevant in determining the
reasonableness of the steps taken to verify accredited investor status. An issuer that solicits new
investors through a website accessible to the general public, through a widely disseminated email
or social media solicitation, or through print media, such as a newspaper, will likely be obligated
to take greater measures to verify accredited investor status than an issuer that solicits new
investors from a database of pre-screened accredited investors created and maintained by a
reasonably reliable third party. The SEC believes that an issuer will be entitled to rely on a third
party that has verified a persons status as an accredited investor, provided that the issuer has a
reasonable basis to rely on such third-party verification. The SEC does not believe that an issuer
will have taken reasonable steps to verify accredited investor status if it, or those acting on its
behalf, required that a person check a box in a questionnaire or sign a form, absent other
information about the purchaser indicating accredited investor status.
The terms of the offering will also affect whether the verification methods used by the
issuer are reasonable. The SEC continues to believe that there is merit to the view that a
purchasers ability to meet a high minimum investment amount could be a relevant factor to the
issuers evaluation of the types of steps that would be reasonable to take in order to verify that
purchasers status as an accredited investor. By way of example, the ability of a purchaser to
satisfy a minimum investment amount requirement that is sufficiently high such that only
accredited investors could reasonably be expected to meet it, with a direct cash investment that is
not financed by the issuer or by any third party, could be taken into consideration in verifying
accredited investor status.
Safe Harbors: Non-Exclusive Methods of Verifying Accredited Investor Status:
The SEC has included in Rule 506(c) four specific non-exclusive methods of verifying
accredited investor status for natural persons that, if used, are deemed to satisfy the verification
requirement in Rule 506(c). Issuers are not required to use any of these methods, but each of
these methods is an alternative to the general principles-based approach. The SEC has indicated
that these four safe harbors will be narrowly construed. However, even if an issuer is unable to
comply with one of the safe harbors, the types of steps that are outlined in the safe harbors can be
a basis for satisfying the reasonable verification requirement on the principles-based approach
described above.
Income: Review of Tax Returns With a Current Certification. In verifying
whether a natural person is an accredited investor on the basis of income, an issuer is deemed to
satisfy the verification requirement in Rule 506(c) by reviewing copies of any Internal Revenue
Service (IRS) form that reports income, including, but not limited to, a Form W-2 (Wage and
Tax Statement), Form 1099 (report of various types of income), Schedule K-1 of Form 1065
(Partners Share of Income, Deductions, Credits, etc.), and a copy of a filed Form 1040 (U.S.
Individual Income Tax Return), for the two most recent years, along with obtaining a written

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representation from such person that he or she has a reasonable expectation of reaching the
income level necessary to qualify as an accredited investor during the current year. In the case of
a person who qualifies as an accredited investor based on joint income with that persons spouse,
an issuer would be deemed to satisfy the verification requirement in Rule 506(c) by reviewing
copies of these forms for the two most recent years in regard to, and obtaining written
representations from, both the person and the spouse. This safe harbor verification method is not
available with respect to prospective investors who file tax returns in foreign jurisdictions but not
in the U.S., and it is not available if, due to the timing of the offering in the tax year, the
prospective investors tax returns for the two prior years are not available at the time of sale.
Net Worth: Review of Specified Documents Within 3 Month Window. In
verifying whether a natural person is an accredited investor on the basis of net worth, an issuer is
deemed to satisfy the verification requirement in Rule 506(c) by reviewing the documentation
described below, dated within the prior three months, and by obtaining a written representation
from such person that all liabilities necessary to make a determination of net worth have been
disclosed. In the case of a person who qualifies as an accredited investor based on joint net
worth with that persons spouse, an issuer would be deemed to satisfy the verification
requirement in Rule 506(c) by reviewing such documentation in regard to, and obtaining
representations from, both the person and the spouse. The documentation that must be reviewed
by an issuer to comply with this method of satisfying Rule 506(c) consists of (i) a credit report
from at least one of the nationwide consumer reporting agencies; and (ii) one or more of the
following: bank statements, brokerage statements and other statements of securities holdings,
certificates of deposit, tax assessments and appraisal reports issued by independent third parties.
Credit reports from foreign reporting agencies analogous to the three U.S. nationwide agencies
will not satisfy the safe harbor. The reviewed documents must be dated within three months of
the date of the sale of securities, which limits the utility of this safe harbor. If an issuer reviews
documents and makes a determination that the purchaser is an accredited investor at the outset of
an offering, or at the time a subscription is accepted into escrow, but does not close on the
transaction for three months or more, the issuer would have failed to satisfy this method of
verification. A tax assessment that is older than three months, even if it is the most recent tax
assessment and even though tax assessments are typically performed only on an annual basis,
will not satisfy this safe harbor.
Written Third Party Confirmation. An issuer is deemed to satisfy the
verification requirement in Rule 506(c) by obtaining a written confirmation from a registered
broker-dealer, an SEC-registered investment adviser, a licensed attorney, or a certified public
accountant that such person or entity has taken reasonable steps to verify that the purchaser is an
accredited investor within the prior three months and has determined that such purchaser is an
accredited investor. There is no requirement that an attorney or certified public accountant be
licensed or registered in the U.S. in order to provide the certification. While third-party
confirmation by one of these parties will be deemed to satisfy the verification requirement in
Rule 506(c), depending on the circumstances, an issuer may be entitled to rely on the verification
of accredited investor status by a person or entity other than one of these parties, provided that
any such third party takes reasonable steps to verify that purchasers are accredited investors and
has determined that such purchasers are accredited investors, and the issuer has a reasonable
basis to rely on such verification.

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Safe Harbor for Accredited Investors in a Prior Offering. An issuer will
be deemed to satisfy the requirements of Rule 506(c) with respect to a prospective purchaser if
that purchaser (i) previously invested in the issuers Rule 506(b) offering as an accredited
investor, and (ii) certifies in writing that such prospective purchaser is still an accredited investor
at the time of the Rule 506(c) sale. The requirement that the prospective purchaser be an
investor in the issuer in a prior offering does not extend to affiliates of the issuer or common
sponsors; if NewCo and OldCo are both sponsored by Investment Fund, a purchaser of NewCo
securities will not fall within the existing investor safe harbor by reason of being an existing
investor in OldCo.
Amendment to Form D:
Form D is the notice of an offering of securities conducted without registration under the
Securities Act in reliance on Regulation D. Under Rule 503 of Regulation D, an issuer offering
or selling securities in reliance on Rule 504, 505 or 506 must file a notice of sales on Form D
with the SEC for each new offering of securities no later than 15 calendar days after the first sale
of securities in the offering.
The SEC adopted revisions to Form D in connection with the adoption of Rule 506(c).
Issuers conducting Rule 506(c) offerings must indicate that they are relying on the Rule 506(c)
exemption by marking the new check box in Item 6 of Form D. The prior check box for Rule
506 has been renamed Rule 506(b).
The SEC is of the view that an issuer will not be permitted to check both boxes at the
same time for the same offering. According to the SECs long-held views, once a general
solicitation has been made to the purchasers in the offering, an issuer is precluded from making a
claim of reliance on Rule 506(b), which remains subject to the prohibition against general
solicitation, for that same offering.
If an issuer begins a Rule 506(b) offering and files a Form D, and then later decides to
transition to a Rule 506(c) offering to make use of advertising or general solicitation, the issuer
will need to file an amendment to the Form D to indicate its reliance on Rule 506(c).
Hedge Funds, Private Equity Groups and Venture Capital Funds:
Private funds, such as hedge funds, venture capital funds and private equity funds,
typically rely on Section 4(a)(2) and Rule 506 to offer and sell their interests without registration
under the Securities Act. In addition, private funds generally rely on one of two exclusions from
the definition of investment company under the Investment Company Act Section 3(c)(1)144
and Section 3(c)(7) which enables them to be excluded from substantially all of the regulatory
provisions of that Act. Those exclusions are only available to private funds that are not making
or propose to make public offerings. The SEC has historically regarded Rule 506 transactions as
non-public offerings for purposes of Sections 3(c)(1) and 3(c)(7). The SEC reaffirmed that the
effect of Section 201(b) of the J OBS Act is to permit private funds to engage in general
solicitation in compliance with new Rule 506(c) without losing either of the exclusions under the
Investment Company Act.

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Many hedge funds have been reluctant to use general solicitation to offer securities
because of the possibility it would be inconsistent with exemptions related to CPO (commodity
pool operator) regulations administered by the CFTC. More specifically:

CFTC Regulation 4.7 provides relief from certain of the disclosure, periodic and
annual reporting, and recordkeeping requirements. Regulation 4.7(b) provides a CPO
may claim exemptive relief if it is a registered CPO who offers or sells participations
in a pool solely to qualified eligible persons, or QEPs, in an offering which qualifies
for exemption from the registration requirements of the Securities Act pursuant to
section 4(2) (now section 4(a)(2), as amended by the J OBS Act) of that Act or
pursuant to Regulation S.
CFTC Regulation 4.13(a)(3) provides a registration exemption for CPOs who operate
pools meeting the conditions enumerated in the regulation, including interests in each
pool for which the CPO claims the exemption be exempt from registration under the
33 Act and offered and sold without marketing to the public in the United States.
Obviously, hedge fund sponsors were concerned that use of general solicitation to place
securities would be inconsistent with the requirement to comply with the Section 4(a)(2)
exemption or the CFTC restriction on marketing to the public.

In a no-action letter the CFTC confirmed its view that the use of general solicitation
would not permit reliance on the foregoing exemptions but then granted no-action relief that
permits the use of general solicitation if the terms of the no action letter are complied with. The
conditions are:

The issuer musty comply with the requirements of Rule 506(c) regarding general
solicitation or if resellers comply with related Rule 144A requirements.
The relief is not self-executing. A notice filing must be made with the CFTC that
contains the information specified in the no-action letter and is filed in the manner
specified.
No General Solicitations in Section 4(a)(2) Private Placements:
Advertising and general solicitation are permitted only in offerings conducted pursuant to
Rule 506(c), and not in Section 4(a)(2) offerings in general. Section 4(a)(2) is the traditional
statutory exemption for private offerings. This means that even after the effective date of Rule
506(c), an issuer relying on Section 4(a)(2) outside of the Rule 506(c) exemption will be
restricted in its ability to make public communications to solicit investors for its offering because
public advertising will continue to be incompatible with a claim of exemption under Section
4(a)(2).
In a traditional Rule 506 offering (now a Rule 506(b) offering), the exemption in Section
4(a)(2) of the Securities Act provided a safety net of sorts; even if an issuer failed to meet all of
the requirements of the Rule 506 exemption, the issuer could always fall back on the exemption

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provided in Section 4(a)(2). In a Rule 506(c) offering, this may not be the case. If an issuer
attempts to comply with Rule 506(c) but fails to fulfill the requirements of the rule, the Section
4(a)(2) exemption will not be available to the issuer if the issuer has engaged in advertising or
general solicitation in connection with the offering.
Final SEC Rule Disqualifying Bad Actors From Rule 506 Offerings
The SEC has adopted final rules to implement Section 926 of the Dodd-Frank Wall Street
Reform and Consumer Protection Act. Section 926 required the SEC to adopt rules that
disqualify securities offerings involving certain felons and other bad actors from reliance on
Rule 506 of Regulation D.
Covered Persons:
The disqualification provisions of Rule 506(d) will cover the following persons, which
the SEC refers to as covered persons:
the issuer and any predecessor of the issuer or affiliated issuer;
any director, executive officer, other officer participating in the offering, general
partner or managing member of the issuer;
any beneficial owner of 20% or more of the issuers outstanding voting equity
securities, calculated on the basis of voting power;
any investment manager to an issuer that is a pooled investment fund and any
director, executive officer, other officer participating in the offering, general partner
or managing member of any such investment manager, as well as any director,
executive officer or officer participating in the offering of any such general partner or
managing member;
any promoter connected with the issuer in any capacity at the time of the sale;
any person that has been or will be paid (directly or indirectly) remuneration for
solicitation of purchasers in connection with sales of securities in the offering (which
we refer to as a compensated solicitor); and
any director, executive officer, other officer participating in the offering, general
partner, or managing member of any such compensated solicitor.
The final rules include a provision under which events relating to certain affiliated issuers are not
disqualifying if they pre-date the affiliate relationship.
Determining who an issuers covered persons are can be tricky in certain circumstances.
For example, if a shareholder becomes a covered person as a result of a purchase of securities
in an ongoing private offering, if the covered person is subject to a disqualifying event, the issuer
will be disqualified from relying on Rule 506 for all future sales in the offering. For this reason,

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issuers should conduct due diligence on any person who will become a 20% owner in an
offering. Voting agreements and shared voting power over shares can also create difficulties in
identifying covered persons. All shares that are subject to a voting agreement may be
considered, as a group, to constitute a covered person. If a group of owners designates one
person to hold voting power with respect to pooled shares, the person holding the voting power
is considered to be the covered person.
The SEC has also indicated that in some cases, officers of a compensated solicitor will be
deemed to be participating in the offering and therefore subject to the bad actor
disqualifications. While an officer of a compensated solicitor that performs mainly
administrative tasks in connection with the offering will not be considered a covered person, an
officer who actively solicits investors in the offering will be considered a covered person.
Between those clear cases, there are likely many gray areas for which the SEC has not provided
guidance.
In some cases, an issuer can take action to terminate a covered persons involvement with
the company or in the offering when a disqualifying event occurs. If a placement agent becomes
subject to a disqualification while an offering is ongoing, the issuer can continue to rely on Rule
506 as long as it terminates the engagement with the placement agent and pays no compensation
to the agent for future sales. A similar concept applies when only one or a subset of covered
persons associated with the placement agent are affected by a disqualification event (i.e., the
offering can continue as long as the persons subject to the disqualifying event are terminated by
the placement agent or reduced to roles that do not make them covered persons for purposes of
Rule 506(d)). Its unclear how soon after the disqualifying event the termination of covered
person status must occur in order to allow the issuer to continue to rely on Rule 506, or how sales
of securities in the offering after the disqualifying event but before termination of the covered
person will be treated.
Disqualifying Events:
Under Rule 506(d), a covered person is subject to a disqualifying event if the covered
person:
Has been convicted, within ten years before such sale (or five years, in the case of
issuers, their predecessors and affiliated issuers), of any felony or misdemeanor:
o In connection with the purchase or sale of any security;
o Involving the making of any false filing with the SEC; or
o Arising out of the conduct of the business of an underwriter, broker, dealer,
municipal securities dealer, investment adviser or paid solicitor of purchasers of
securities; or
Is subject to any order, judgment or decree of any court of competent jurisdiction,
entered within five years before such sale, that, at the time of such sale, restrains or
enjoins such person from engaging or continuing to engage in any conduct or
practice:
o In connection with the purchase or sale of any security;

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o Involving the making of any false filing with the SEC; or
o Arising out of the conduct of the business of an underwriter, broker, dealer,
municipal securities dealer, investment adviser or paid solicitor of purchasers of
securities; or

Is subject to a final order of a state securities commission (or an agency or officer of a
state performing like functions); a state authority that supervises or examines banks,
savings associations, or credit unions; a state insurance commission (or an agency or
officer of a state performing like functions); an appropriate federal banking agency;
the U.S. Commodity Futures Trading Commission; or the National Credit Union
Administration that:
o At the time of such sale, bars the person from:
Association with an entity regulated by such commission, authority, agency,
or officer;
Engaging in the business of securities, insurance or banking; or
Engaging in savings association or credit union activities; or
o Constitutes a final order based on a violation of any law or regulation that
prohibits fraudulent, manipulative, or deceptive conduct entered within ten years
before such sale; or

Is subject to an order of the SEC entered pursuant to section 15(b) or 15B(c) of the
Securities Exchange Act of 1934 (15 U.S.C. 78o(b) or 78o-4(c)) or section 203(e) or
(f) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-3(e) or (f)) that, at the time
of such sale:
o Suspends or revokes such persons registration as a broker, dealer, municipal
securities dealer or investment adviser;
o Places limitations on the activities, functions or operations of such person; or
o Bars such person from being associated with any entity or from participating in
the offering of any penny stock; or

Is subject to any order of the SEC entered within five years before such sale that, at
the time of such sale, orders the person to cease and desist from committing or
causing a violation or future violation of:
o Any scienter-based anti-fraud provision of the federal securities laws, including
without limitation section 17(a)(1) of the Securities Act of 1933 (15 U.S.C.
77q(a)(1)), section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C.
78j(b)) and 17 CFR 240.10b-5, section 15(c)(1) of the Securities Exchange Act of
1934 (15 U.S.C. 78o(c)(1)) and section 206(1) of the Investment Advisers Act of
1940 (15 U.S.C. 80b-6(1)), or any other rule or regulation thereunder; or
o Section 5 of the Securities Act of 1933 (15 U.S.C. 77e); or

Is suspended or expelled from membership in, or suspended or barred from
association with a member of, a registered national securities exchange or a registered
national or affiliated securities association for any act or omission to act constituting
conduct inconsistent with just and equitable principles of trade; or

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Has filed (as a registrant or issuer), or was or was named as an underwriter in, any
registration statement or Regulation A offering statement filed with the SEC that,
within five years before such sale, was the subject of a refusal order, stop order, or
order suspending the Regulation A exemption, or is, at the time of such sale, the
subject of an investigation or proceeding to determine whether a stop order or
suspension order should be issued; or

Is subject to a United States Postal Service false representation order entered within
five years before such sale, or is, at the time of such sale, subject to a temporary
restraining order or preliminary injunction with respect to conduct alleged by the
United States Postal Service to constitute a scheme or device for obtaining money or
property through the mail by means of false representations.
Reasonable Care Exception:
The Rule 506 exemption is still available if the issuer establishes that it did not know and,
in the exercise of reasonable care, could not have known that a disqualification existed under the
bad actor provision. The SEC believes the steps an issuer should take to exercise reasonable care
will vary according to the particular facts and circumstances. For example, the SEC anticipates
that issuers will have an in-depth knowledge of their own executive officers and other officers
participating in securities offerings gained through the hiring process and in the course of the
employment relationship, and in such circumstances, further steps may not be required in
connection with a particular offering. Factual inquiry by means of questionnaires or
certifications, perhaps accompanied by contractual representations, covenants and undertakings,
may be sufficient in some circumstances, particularly if there is no information or other
indicators suggesting bad actor involvement.
The SEC also believes the time frame for inquiry should also be reasonable in relation to
the circumstances of the offering and the participants. Consistent with this standard, the SEC
stated the objective should be for the issuer to gather information that is complete and accurate as
of the time of the relevant transactions, without imposing an unreasonable burden on the issuer
or the other participants in the offering. However, with respect to offerings that are continuous,
delayed, or long-lived, the SEC anticipates that an issuer will need to periodically update its
factual inquiry into its covered persons in order to continue meeting the reasonable care
exception. Its unclear how frequently an issuer must update its inquiry or how long an offering
must be ongoing in order to require an update to the inquiry. The SEC expects that issuers will
determine the appropriate dates to make a factual inquiry, based upon the particular facts and
circumstances of the offering and the participants involved, to determine whether any covered
persons are subject to disqualification before seeking to rely on the Rule 506 exemption.
The SEC noted issuers should make factual inquiry of the covered persons, but in some
casesfor example, in the case of a registered broker-dealer acting as placement agentit may
be sufficient to make inquiry of an entity concerning the relevant set of covered officers and
controlling persons, and to consult publicly available databases concerning the past disciplinary
history of the relevant persons.

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Waivers:
The rules provide the SEC can provide a waiver from the bad actor disqualification upon
a showing of good cause and without prejudice to any other action by the SEC, if the SEC
determines that it is not necessary under the circumstances that an exemption be denied.
A waiver can also be granted by the court or regulatory authority that enters the relevant
order, judgment or decree advising in writing that the bad actor disqualification should not arise
as a consequence of such order, judgment or decree. However, the SEC has indicated that
waivers are not possible with respect to the requirement, under Rule 506(e) (discussed below),
that issuers disclose certain past conduct of covered persons.
As of August 22, 2014, the SEC had granted five waivers of the Rule 506 bad actor
disqualification. The SEC has indicated that past waiver requests that have been granted may be
a source of guidance for determining what factors will lead the SEC to grant a waiver. The
common elements in the five waivers that have been granted thus far appear to be: (i) the
disqualifying conduct was not directly related to the offering and sale of securities, (ii) the
company seeking the waiver has fully cooperated with the SEC in carrying out its obligations
pursuant to settlement agreements and orders, and (iii) third parties who do business with the
company would be harmed as a result of the companys disqualification from relying on Rule
596. The SECs adopting release for the bad actor disqualification from Rule 506 also notes that
the following factors may be relevant for determining whether a waiver is appropriate: (i) change
of control of the company, (ii) change of supervisory personnel, (iii) absence of notice and
opportunity for hearing, and (iv) relief from a permanent bar for a person who does not intend to
apply to re-associate with a regulated entity.
Disqualifying Events Prior to the Effective Date; Disclosure:
The final rule includes a provision specifying that disqualification will not arise as a
result of triggering events that occurred before the effective date of the rule amendments which
was September 23, 2013. Although no disqualification results, Rule 506(e) requires disclosure to
investors regarding such events. Issuers will be required to provide disclosure a reasonable
time prior to sale.
If disclosure is required and not adequately provided to an investor, the SEC does not
believe that relief will be available under Rule 508, under which insignificant deviations from
Regulation D requirements do not necessarily result in loss of the Securities Act exemption with
regard to an offer or sale of securities to a particular individual or entity. The reason is for Rule
508 to apply to an offer or sale of securities, the failure to comply with a Regulation D
requirement must not pertain to a term, condition or requirement directly intended to protect that
offeree or purchaser.
New Rule 506(e) does, however, provide that the failure to furnish required disclosure on
a timely basis will not prevent an issuer from relying on Rule 506 if the issuer establishes that it
did not know, and in the exercise of reasonable care could not have known, of the existence of
the undisclosed matter or matters. This reasonable care exception to the disclosure requirement
is similar to the reasonable care exception to disqualification described above, and will

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preserve an issuers claim to reliance on Rule 506 if disclosure is required but the issuer can
establish that it did not know and in the exercise of reasonable care could not have known of the
matters required to be disclosed. The provision also includes an instruction, clarifying that
reasonable care requires factual inquiry.
New Form D:
Form D has also been revised. As revised the signature block of the Form D contains a
certification, whereby issuers claiming a Rule 506 exemption confirm that the offering is not
disqualified from reliance on Rule 506 as a result of the bad actor disqualification provisions.
V. PROPOSED REGULATION A+
On December 18, 2013, the SEC published its proposal to modify Regulation A. The
SEC is proposing to expand Regulation A into two tiers: Tier 1, for offerings of up to $5 million;
and Tier 2, for offerings of up to $50 million. The proposed rules also seek to modernize the
Regulation A filing process to create additional flexibility and streamline compliance for
Regulation A issuers.
Advantages of Regulation A+include:
The ability to publicly offer securities without a full registration process
Securities sold are not restricted securities and can be transferred freely
Available to issuers that do not qualify as emerging growth companies under
the J OBS Act
There is no strict liability for public offerings under Section 11 of the Securities
Act
Investment Limitations
The proposed rules contain new investment limitations. For a Tier 2 offering an investor
is limited to purchasing securities with a purchase price of no more than 10% of the greater of
the investors annual income and net worth. Issuers would not be required to verify individual
income and net worth and could rely on investor representations of compliance. No similar
limitation applies to Tier 1 offerings.
Offering Statement
The proposed rules update Regulation A to require electronic filing of offering statements
on the EDGAR System. A From 1-A would be developed that is a fill-in-the-blank form similar
to Form D and then other disclosure documents and exhibits would be attached. Ongoing reports
would also be filed electronically. The SEC is also proposing an access-equals-delivery model
for Regulation A final offering circulars. The SEC also proposes to allow the non-public
submission of draft offering statements by issuers of Regulation A securities.

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The SEC Proposes to maintain Form 1-As existing three-part structure Part 1
(Notification), Part II (Offering Circular), and Part III (Exhibits). Part I would be updated to be
an online XML-Based fillable form that would be publicly available on EDGAR but not
otherwise required to be distributed to investors. Part II would be updated to eliminate Model A
(the Q-and-A format) as a disclosure option and to update and retain Model B as a disclosure
option and to continue to permit issuers to rely on Part I of Form S-1 to satisfy the disclosure
obligations of Part II of Form 1-A. The primary update to Model B would be to propose
disclosure similar to that of smaller reporting companies. The proposed rules would maintain the
existing financial statement requirements for Tier 1 Offerings but require issuers in Tier 2 to
include two years of audited financial statements.
Reporting Obligations
Tier I issuers will be required to file certain summary information about the Regulation A
offering on Part I of new Form I-Z within 30 days after the completion or termination of the
Regulation A offering. This is actually a reduction in the reporting burden for Tier I issuers, as
the current rules require similar information to be reported every six months after qualification
and within 30 days after termination or completion of the offering.
Under the proposed rules, Tier II issuers would be required to file four types of reports:
an annual report on Form 1-K (which must include audited financial statements), a semi-annual
report on Form 1-SA, a report of certain updates on Form I-U, and a report notifying the
Commission of the termination of ongoing reporting obligations on Form I-Z.
Relationship with State Securities Laws
The proposal provides that offers and sales of Tier 2 securities under revised Regulation
A would preempt state blue sky requirements. Only offers of Tier 1 securities would remain
subject to state blue sky requirements.
VI. PROPOSED CROWDFUNDING RULES
The SEC has proposed new Regulation Crowdfunding to implement the requirements of
Title III of the J OBS Act. Regulation Crowdfunding would prescribe rules governing the offer
and sale of securities under new Section 4(a)(6) of the Securities Act of 1933. The proposal also
provides a framework for the regulation of registered funding portals and brokers that issuers are
required to use as intermediaries in the offer and sale of securities in reliance on Section 4(a)(6).
A. Crowdfunding Exemption
Limitation on Capital Raised
The exemption from registration provided by Section 4(a)(6) is available to a U.S. issuer
provided that the aggregate amount sold to all investors by the issuer, including any amount
sold in reliance on the exemption provided under [Section 4(a)(6)] during the 12-month period
preceding the date of such transaction, is not more than $1,000,000. Capital raised through
means other than the crowdfunding exemption is not counted towards the $1,000,000 maximum.

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The SEC believes that an offering made in reliance on Section 4(a)(6) should not be
integrated with another exempt offering made by the issuer, provided that each offering complies
with the requirements of the applicable exemption that is being relied upon for the particular
offering. An issuer could complete an offering made in reliance on Section 4(a)(6) that occurs
simultaneously with, or is preceded or followed by, another exempt offering. An issuer
conducting a concurrent exempt offering for which general solicitation is not permitted,
however, would need to be satisfied that purchasers in that offering were not solicited by means
of the offering made in reliance on Section 4(a)(6). Similarly, any concurrent exempt offering
for which general solicitation is permitted could not include an advertisement of the terms of an
offering made in reliance on Section 4(a)(6) that would not be permitted under Section 4(a)(6)
and the proposed rules.
Investment Limitation
Under Section 4(a)(6)(B), the aggregate amount sold to any investor by an issuer,
including any amount sold in reliance on the exemption during the 12-month period preceding
the date of such transaction, cannot exceed:
the greater of $2,000 or 5 percent of the annual income or net worth of such investor,
as applicable, if either the annual income or the net worth of the investor is less than
$100,000; and
10 percent of the annual income or net worth of such investor, as applicable, not to
exceed a maximum aggregate amount sold of $100,000, if either the annual income or
net worth of the investor is equal to or more than $100,000.
There is a glitch in the drafting of the statute because the language if either the annual income
or net worth of the investor is equal to or more than $100,000 can cause both limitations to be
applicable. The SEC believes that the appropriate approach to the investment limit provision is
to provide for an overall investment limit of $100,000, but within that overall limit, to provide
for a greater of limitation based on annual income and net worth. Under the proposed rules,
therefore, if both annual income and net worth are less than $100,000, then a limit of $2,000 or 5
percent of annual income or net worth, whichever is greater, would apply. If either annual
income or net worth exceeds $100,000, then a limit of 10 percent of annual income or net worth,
whichever is greater, but not to exceed $100,000, would apply.
The proposed rules require a natural persons annual income and net worth to be
calculated in accordance with the SECs rules for determining accredited investor status. The
proposed rules would clarify that an investors annual income and net worth may be calculated
jointly with the income and net worth of the investors spouse.
The proposal allows an issuer to rely on efforts that an intermediary takes in order to
determine that the aggregate amount of securities purchased by an investor will not cause the
investor to exceed the investor limits, provided that the issuer does not have knowledge that the
investor had exceeded, or would exceed, the investor limits as a result of purchasing securities in
the issuers offering.

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Transactions Conducted Through an Intermediary
Under Section 4(a)(6)(C), a transaction in reliance on Section 4(a)(6) must be conducted
through a broker or funding portal that complies with the requirements of [S]ection 4A(a). The
proposed rules require that an intermediary, in a transaction involving the offer or sale of
securities in reliance on Section 4(a)(6), effect such transactions exclusively through an
intermediarys platform. The SEC proposes to define the term platform to mean an Internet
website or other similar electronic medium through which a registered broker or a registered
funding portal acts as an intermediary in a transaction involving the offer or sale of securities in
reliance on Section 4(a)(6).
Ineligible Issuers
These following issuers are excluded from relying on the crowdfunding exemption:
Issuers not organized under the laws of a state or territory of the United States or the
District of Columbia;
issuers that are subject to Exchange Act reporting requirements;
investment companies as defined in the Investment Company Act or companies that
are excluded from the definition of investment company under Section 3(b) or 3(c) of
the Investment Company Act;
any issuer that has sold securities in reliance on Section 4(a)(6) if the issuer has not
filed with the Commission and provided to investors, to the extent required, the
ongoing annual reports required by Regulation Crowdfunding during the two years
immediately preceding the filing of the required new offering statement;
issuers subject to the bad boy disqualifiers in Section 302(d) of the J OBS Act; and
any issuer that has no specific business plan or has indicated that its business plan is
to engage in a merger or acquisition with an unidentified company or companies.
B. Filing and Disclosure Requirements for Issuers
Prohibitions Applicable to the Issuer
Proposed Regulation Crowdfunding places several restrictions on issuer conduct in
connection with a crowdfunded offering relating to advertising and promotion of the offering and
its terms.
Prohibition on Advertising Terms of the Offering:
Under the proposed rules, an issuer would be prohibited from advertising an offering
pursuant to Section 4(a)(6), except that the issuer would be permitted to distribute a notice that
includes only the following information with respect to the offering:

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A statement that the issuer is conducting an offering, the name of the intermediary,
and a link to the intermediarys offering.
The amount of securities offered, the nature of the securities, the price of the
securities, and the closing date for the offering.
The name, address, phone number, and website of the issuer, the e-mail address of a
representative of the issuer, and a brief factual description of the issuers business.
Although the content of these notices is restricted, the proposed rules do not restrict the means by
which the notices may be distributed. Further, the issuer is free to communicate with the public
about other aspects of its business during the pendency of a Section 4(a)(6) offering as long as
the issuer does not disclose any information about the offering other than the information
permitted on notices. The rules also permit direct communication between the issuer and
potential investors about the offering, including while the offering is ongoing, provided that the
communications occur through the intermediarys platform and the issuer identifies itself as the
issuer in all such communications.
Disclosure of Promoter Compensation:
The proposed rules prohibit issuers from agreeing to compensate any person for
promoting Section 4(a)(6) other than through the communication channels associated with the
intermediarys platform unless the promotion is limited to distributing notices that merely direct
the recipient to the funding platform (as discussed above). An issuer is permitted to compensate
a person for promoting an offering through the communication channels of the intermediarys
platform, but only if the issuer also takes reasonable steps to ensure that, with every promotional
communication, the promoter clearly discloses the past and prospective receipt of compensation
from the issuer. This rule applies not only third party promoters, but also to employees or
shareholders of the issuer and any other person that undertake promotional activities on behalf of
the issuer through the intermediarys platform.
Form C and Filing Requirements
The rules propose a new Form C (with several variations) that would be used by issuers
in Section 4(a)(6) offerings to file the required information and disclosures with the SEC and to
provide the information to the applicable intermediary.
Form C: Offering Statement:
The initial disclosure regarding the offering would be filed on Form C, and the issuer
would fulfill its filing obligations by filing Form C: Offering Statement with the SEC, providing
the intermediary with a copy of the filing, and directing investors to the filing on the
intermediarys platform through a posting on the issuers website or by e-mail notification. The
specific disclosure requirements of Form C are discussed in detail below.

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Form C-A: Amendments to the Offering Statement:
Form C filings can be amended by filing Form C-A with the SEC. Issuers may amend
their Form C filings to account for changes in offering information, and issuers must amend their
Form C filings to reflect any material changes in the offering terms or disclosures previously
provided to investors. The SEC considers a material change to be one involving information
with respect to which there is a substantial likelihood that a reasonable investor would consider it
important in deciding whether or not to purchase the offered securities, under the facts and
circumstances. Examples of material changes include changes to the financial condition of the
issuer, changes to the intended use of proceeds of the offering, and determination of the final
price of the securities being offered if only the methodology for determining the final offering
price has previously been disclosed.
If there is a material change, the issuer will be required to check a box on Form C-A
indicating that there has been a material change and that the issuer will not accept any investment
from investors who have previously committed to purchase securities in the offering unless the
investors reconfirm their commitment in light of the material change.
Form C-U: Progress Updates:
Under the proposed rules, issuers would be required to file with the SEC (and provide to
the intermediary and potential investors) periodic updates on the progress of the offering on new
Form C-U filed via the EDGAR system. Updates would be required within five days after (i) the
issuer has received commitments for 50% of the offering amount, (ii) the issuer has received
commitments for 100% of the offering amount; (iii) the issuer intends to accept subscriptions in
excess of the offering amount; and (iv) the issuer has closed on proceeds of the offering.
Form C-AR: Ongoing Annual Reporting Obligations:
An issuer that sells securities in a crowdfunded offering will be required to file an annual
report with the SEC on Form C-AR and to make that annual report available to investors by
posting the report on the issuers website. The annual report will be due no later than 120 days
after the end of the most recent fiscal year, and must include information similar to the
information provided in the initial Form C filing for a crowdfunded offering (including financial
statements meeting the requirements of a Section 4(a)(6) offering), except that the annual report
will not include information that is specific to an offering of securities.
Form C-TR: Termination of Reporting:
The annual report obligation would continue until (i) the issuer becomes an Exchange
Act reporting company, (ii) all of the securities issued in crowdfunded transactions are redeemed
or purchased by another party, or (iii) the issuer liquidates or dissolves its business.
When an issuer is no longer subject to the ongoing reporting obligations, it will be
required to file a Form C-TR: Termination of Reporting, which will serve as a notice to the SEC
and investors that it is no longer required to provide the annual reports on Form C-AR.

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Required Disclosures of Offering Information
The following sections discuss information that would be required to be disclosed by an
issuer on Form C pursuant to the proposed rules.
Basic Issuer Information; Officers and Directors:
The issuer would be required to disclose basic information about its identify and status,
including its name, legal status, form of organization, date and jurisdiction of organization, and
physical and website addresses, the current number of employees of the issuer, and the SEC file
number and CRD number of the intermediary being used for the Section 4(a)(6) offering and the
amount being paid to that intermediary in connection with the offering (including any referral or
other fees).
The issuer would also be required to disclose information about its directors and officers,
defined to include the president, vice president, secretary, treasurer or principal financial officer,
comptroller or principal accounting officers, and any person who routinely performs
corresponding functions for the issuer.
For officers and directors, the issuer would need to disclose each individuals name,
positions held with the issuer, duration in those positions, and business experience (including
principal occupation) during the last three years. For officers, the issuer would need to disclose
whether the officer has been employed by another employer and the name and principal business
of that employer. Since similar disclosures by issuers are required for the prior five years in
connection with registered offerings and offerings under Regulation A, the SEC sees this
disclosure relating to only the prior three years as an accommodation to startups relying on the
crowdfunding rules.
Certain 20% Beneficial Owners:
The issuer would be required to disclose the names of each shareholder who owns 20%
or more of the issuers outstanding voting equity securities, calculated by voting power as of the
most recent practicable date. In coming up with this formulation, the SEC is resolving some
ambiguity in the J OBS Act in favor of startups; the J OBS Act arguably could require disclosure
of holders of 20% or more of each class of an issuers securities. The SEC also believes that
making the date of calculation flexible (as of the most recent practicable date) is to the benefit
of issuers and ensures that issuers are not subject to more stringent calculation requirements than
those applicable to issuers in registered offerings.
Business Plan and Use of Proceeds:
The SEC is proposing a flexible approach to the required disclosures of a business plan
and intended use of offering proceeds. While a business plan is required, the form and content of
the business plan has not been prescribed, and the SEC has indicated that the business plan can
be tailored to fit the stage of the business. In the use of proceeds disclosure, the SEC is requiring
disclosure that is reasonably detailed under the circumstances. The proposing release provides
several examples of the type of disclosure that would be appropriate under the circumstances,

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stating, for example, that If an issuer does not have definitive plans for the proceeds, but instead
has identified a range of possible uses, then the issuer should identify and describe each probable
use and factors impacting the selection of each particular use.
Target offering Amount and Deadlines:
If an issuer will accept investments beyond the targeted offering amount, under the
proposed rules it must disclose this fact in its Form C filing, along with a statement of the
maximum amount the issuer will accept under any circumstances and a description of how the
oversubscribed securities would be allocated among investors.
Form C would also require clear disclosures regarding offering closing procedures, the
circumstances under which an investor could cancel their investment, and the circumstances
under which the issuer could close the offering early. These disclosures must include the
following required information:
Investors can cancel their investment up to 48 hours prior to the deadline identified in
the offering materials, but if an investor does not cancel the investment, then their
funds will be released to the issuer upon closing;
The intermediary will notify investors when the target offering amount has been met,
and if the target offering amount is not met then no securities will be sold and all
funds will be returned to investors;
If the target offering amount is met prior to the deadline identified in the offering
materials, the issuer must provide five days advance notice before closing the offering
early; and
If an investor does not reconfirm the investment commitment after a material change
is made to the offering and disclosed on Form C-A, the investment will be cancelled
and the issuer must return the funds to the investor.
Ownership and Capital Structure:
Under the proposed rules, issuers would be required to include detailed information
regarding the issuers ownership and capital structure in the Form C filing, including:
Descriptions of the characteristics of each class of securities of the issuer, including
the securities being offered, and a description of the difference between the different
classes of securities, with an emphasis on voting rights and the way the rights of the
securities being offered can be modified or limited;
Descriptions of the material terms of any indebtedness of the issuer;
A description of how the exercise of the rights held by principal shareholders could
affect purchasers of the offered securities;

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The name and ownership level of 20% beneficial holders;
Descriptions of certain related party transactions among the issuer and any officer,
director, promoter, or 20% beneficial owner, or any immediate family member of any
of the foregoing, if the related party transaction was in excess of five percent of the
amount the issuer has raised through crowdfunded offerings in the trailing twelve
months including the amount proposed to be raised in the current offering;
Disclosure of all exempt offerings conducted by the issuer within the last three years,
including the date of each offering, the exemption relied upon, the amount raised, the
type and amount of securities sold, and the use of proceeds;
A description of how the offered securities are being valued and examples of how
securities may be valued in the future, including in subsequent corporate actions;
Disclosure of the risks associated with minority ownership and corporate actions such
as additional issuances of shares, repurchases by the issuer, transactions with related
parties, and a stock or asset sale by the issuer;
Legends regarding the risks of investing in a crowdfunding transaction generally and
the ongoing reporting obligations of the issuer, including details about how those
reports can be obtained;
Discussion of risk factors that make an investment in the issuer risky or speculative;
and
A description of the restrictions on transfer of the offered securities.
Discussion of Financial Condition and Financial Disclosures
Discussion of Financial Condition:
All issuers would be required to submit to the SEC, the relevant intermediary, and
potential investors a description of their financial condition under the proposed rules. The
description of financial condition would be similar to the MD&A discussion required of
Exchange Act reporting companies under Item 303 of Regulation S-K. The description of the
issuers financial condition would need to include a discussion of historical results of operation,
liquidity and capital resources, the proceeds of the offering and other pending sources of capital,
and how the current available and anticipated capital relates to the viability of the issuers
business.
Financial Disclosures:
In all cases, the required financial disclosure under the proposed rules must include a
complete set of financial statements (balance sheet, income statement, statement of cash flows,
and statement of changes in owners equity) prepared in accordance with GAAP and a discussion
of any material changes to the issuers financial condition since the date of the financial

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statements. The level of certification or review required of the financial statements varies
depending on the aggregate amount (i) offered by the issuer in the current offering (including
any oversubscriptions that will be accepted by the issuer), and (ii) offered and sold by the issuer
in a crowdfunded offering in the prior twelve months (referred to here as the aggregate offering
amount).
If the aggregate offering amount is $100,000 or less, the issuer would only need to
provide tax returns (with personal information such as social security numbers redacted) for the
most recently completed year and financial statements that are certified by the issuers principal
executive officer as true and complete in all material respects on a form proposed by the SEC.
If the aggregate offering amount is greater than $100,000 but not more than $500,000, the
issuer would need to provide financial statements that have been reviewed by an independent
public accountant, using the independence standards set forth in Rule 2-01 of Regulation S-X.
The review would need to be based on the American Institute of Certified Public Accountants
(AICPA) standards. A copy the independent public accountants review report would be
included in the disclosures to the SEC, the intermediary, and potential investors.
If the aggregate offering amount is more than $500,000, the issuer would be required to
provide financial statements that have been audited by an independent public accountant (again,
using the Regulation S-X independence standards). The audit could be conducted either using
the AICPA standards or the Public Company Accounting Oversight Board (PCAOB) standards.
A copy of the audit report would need to be included in the disclosures to the SEC, the
intermediary, and potential investors. An issuer that received an adverse audit opinion or a
disclaimer of opinion would be disqualified from engaging in a Section 4(a)(6) offering.
C. Requirements for Crowdfunding Intermediaries
As mentioned above, Section 4(a)(6)(C) requires crowdfunding offerings to be conducted
through a broker or funding portal that complies with Section 4A(a). A funding portal is defined
as any broker acting as an intermediary in a transaction involving the offer or sale of securities
for the account of others, solely pursuant to Securities Act Section 4(a)(6), that does not: (1)
offer investment advice or recommendations; (2) solicit purchases, sales or offers to buy the
securities offered or displayed on its platform or portal; (3) compensate employees, agents or
other person for such solicitation or based on the sale of securities displayed or referenced on its
platform or portal; (4) hold, manage, possess or otherwise handle investor funds or securities; or
(5) engage in such other activities as the Commission, by rule, determines appropriate. In
addition to the foregoing limitations, below is a summary of various requirements placed upon
these crowdfunding intermediaries under Section 4A(a) and the proposed rules.
SEC Registration and FINRA Membership
Each crowdfunding intermediary must be registered with the SEC as a broker or funding
portal. Under the proposal, a crowdfunding intermediary must register as a broker under Section
15(b) of the Exchange Act or as a funding portal under Securities Act Section 4A(a)(1) and
proposed Rule 400 of Regulation Crowdfunding. The proposal sets out a process and form
(Form Funding Portal) for funding portal registration. Additionally, each intermediary will be

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required to be a member of FINRA (or any subsequent national securities association) before
acting as an intermediary.
Financial Interests
The directors, officers and partners of an intermediary are prohibited from having any
financial interest in an issuer using their services. The proposal extends this prohibition to the
intermediary itself, and also prohibits any of these parties from receiving a financial interest in an
issuer as compensation for services related to an offering of the issuer's securities. The proposed
rules interpret any financial interest in an issuer, to mean a direct or indirect ownership of, or
economic interest in, any class of the issuers securities.
Fraud Reduction Measures
Under the proposed rules, the intermediary must take measures to reduce the risk of fraud
in crowdfunding offerings, by requiring intermediaries to:
have a reasonable basis to believe a crowdfunding issuer is in compliance with
relevant regulations (the proposed rules would permit intermediaries to reasonably
rely on representations of the issuer, absent knowledge or other information or
indications that the representations are not true).
have a reasonable basis to believe the issuer has established a means to keep accurate
records of the holders of its securities (for example, use of a direct registration
system, legends on certificates or use of a registered transfer agent, although none of
these are required); the intermediary may rely on an issuers representations
concerning the means it has established to satisfy this requirement, unless the
intermediary has reason to question the reliability of the representations.
deny access to an issuer or offering if the intermediary believes it presents a potential
risk of fraud or if the issuer or any of its officers, director or 20% beneficial owners is
subject to disqualification under the proposed rules. The proposal requires an
intermediary to conduct certain background and regulatory checks on issuers and
such related parties.
If such disqualifying information becomes known to the intermediary after the fact,
the intermediary must promptly remove the offering from its platform, cancel the
offering and return all funds to investors.
Education Materials
The proposed rules would require the intermediary to deliver to investors, at account
opening, educational materials that are in plain language and otherwise designed to communicate
effectively specified information.

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Investor Limits
Each intermediary will be required to ensure no investor exceeds the investment limits.
The proposed rules would allow an intermediary to rely on an investor's representations about its
income and net worth and total crowdfunding investments made in the last 12 months.
Investors Right to Cancel
The intermediary must allow investors to cancel their investment commitments. Under
the proposed rules, investors must be given an unconditional right to cancel their commitment
for any reason until 48 hours before the deadline identified in the issuer's offering materials. The
proposed rules set forth a procedure for issuers to close an offering earlier than the deadline
when it reaches its target funding amount before that time, subject to detailed conditions and
notice periods. Upon making material changes to an offering or terminating an offering,
additional notice and reconfirmation or cancellation requirements would apply.
Communication Channels
The proposed rules will require intermediaries to provide communication channels to
permit discussions among investors and between investors and the issuer about offerings on the
platform, with detailed requirements of these channels set forth in the rules.
ATS/Secondary Market Transactions
Under the proposed rules, facilitating crowdfunded transactions alone would not require
an intermediary to register as an exchange or as an alternative trading system (i.e., registration as
a broker-dealer subject to Regulation ATS). To the extent that an intermediary facilitates
secondary market activity in securities issued in reliance on Section 4(a)(6), the intermediary
would be required to register as an exchange or as an alternative trading system if it met the
criteria in Exchange Act Rule 3b-16. The SEC noted that a funding portal, by definition, is
limited to acting as an intermediary in transactions involving the offer or sale of securities for the
account of others solely pursuant to Section 4(a)(6), which are primary issuances of securities.
Thus, a funding portal could not effect secondary market transactions in securities.
D. Additional Requirements on Funding Portals
Registration
Securities Act Section 4A(a)(1) requires that an intermediary facilitating a transaction
made in reliance on Section 4(a)(6) register with the SEC as a broker or a funding portal. A
funding portal would register with the Commission by filing a form with information consistent
with, but less extensive than, the information required for broker-dealers on Form BD. The new
form will be called Form Funding Portal.
The proposed rules would require, as a condition of registration, that a funding portal
have in place, and thereafter maintain for the duration of such registration, a fidelity bond
meeting certain requirements, including minimum coverage of $100,000.

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Exemption from Broker Dealer Registration
The J OBS Act directs the SEC to exempt a registered funding portal from the
requirement to register as a broker or dealer under Exchange Act Section 15(a), subject to certain
conditions. But for the exemption from registration Congress directed, a funding portal would be
required to register as a broker under the Exchange Act. The obligations imposed under the
J OBS Act on an entity acting as an intermediary in a crowdfunding transaction would bring that
entity within the definition of broker under Exchange Act Section 3(a)(4). A funding portal
would be effecting transactions in securities for the account of others by, among other things,
ensuring that investors comply with the conditions of Securities Act Section 4A(a)(4) and (8),
making the securities available for purchase through the funding portal, and ensuring the proper
transfer of funds and securities as required by Securities Act Section 4A(a)(7). In addition, a
funding portals receipt of compensation linked to the successful completion of the offering also
would be indicative of acting as a broker in connection with these transactions.
The proposed rule exempts an intermediary that is registered as a funding portal from the
requirement to register as a broker-dealer. However the proposed rules require that a funding
portal permit the examination and inspection of all of its business and business operations that
relate to its activities as a funding portal, such as its premises, systems, platforms and records, by
representatives of the SEC, and of the national securities association of which the funding portal
is a member.
E. Other Provisions
Restrictions on Resales
The proposed rules track the J OBS Act and provide that securities issued in reliance on
Section 4(a)(6) may not be transferred by the purchaser for one year after the date of purchase,
except when transferred:
to the issuer of the securities;
to an accredited investor;
as part of an offering registered with the SEC;
to a family member of the purchaser or the equivalent, or
in connection with the death or divorce of the purchaser.
Exemption from Section 12(g)
The J OBS Act requires the SEC to exempt securities issued under Section 4(a)(6) from
the registration requirements of the Exchange Act. Proposed Rule 12g-6 provides that securities
issued pursuant to an offering made under Section 4(a)(6) would be permanently exempted from
the record holder count under Section 12(g). An issuer seeking to exclude a person from the

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record holder count would have the responsibility for demonstrating that the securities held by
the person were initially issued in an offering made under Section 4(a)(6).
FINRA Proposes Rules for Crowdfunding Portals
FINRA has proposed rules and related forms for crowdfunding portals. The proposal,
which reflects the rules recently proposed by the SEC, would implement in FINRAs rules the
provisions of the J OBS Act. FINRA believes it has streamlined the proposed rules to the extent
possible to reflect the limited scope of activity permitted by funding portals while also
maintaining investor protection.
VII. OTHER PENDING JOBS ACT CHANGES
Removal of General Solicitation Requirements Triggers Additional SEC Proposals
As noted, the SEC has adopted final rules eliminating the ban on general solicitations in
Rule 506 offerings. As a result of the magnitude of the changes, the SEC has proposed a number
of amendments in conjunction with the adoption of new Rule 506(c). These amendments:
are intended to enhance the SECs understanding of the Rule 506 market by
improving compliance with Form D filing requirements;
expand the information requirements of Form D, primarily with respect to Rule 506
offerings, and
require the submission, on a temporary basis, of written general solicitation materials
used in Rule 506(c) offerings to the SEC.
Form D and Regulation D:
With respect to Form D and to Regulation D as it relates to Form D, the SEC has
proposed to:
amend Rule 503 of Regulation D to require:
o the filing of a Form D no later than 15 calendar days in advance of the first use of
general solicitation in a Rule 506(c) offering; and
o the filing of a closing Form D amendment within 30 calendar days after the
termination of a Rule 506 offering;
amend Form D to require additional information primarily in regard to offerings
conducted in reliance on Rule 506; and
amend Rule 507 of Regulation D to disqualify an issuer from relying on Rule 506 for
one year for future offerings if the issuer, or any predecessor or affiliate of the issuer,
did not comply, within the last five years, with all of the Form D filing requirements
in a Rule 506 offering.

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Legends for General Solicitation Material:
In addition, in light of the ability of issuers to publicly advertise Rule 506(c) offerings,
the SEC is concerned that prospective investors may not be sufficiently informed as to whether
they are qualified to participate in these offerings, the type of offerings being conducted and
certain potential risks associated with such offerings. To address these concerns, the SEC has
proposed a new Rule 509 of Regulation D, which would require issuers to include prescribed
legends in any written communication that constitutes a general solicitation in any offering
conducted in reliance on Rule 506(c).
The legends would include the following:
The securities may be sold only to accredited investors, which for natural persons, are
investors who meet certain minimum annual income or net worth thresholds;
The securities are being offered in reliance on an exemption from the registration
requirements of the Securities Act and are not required to comply with specific
disclosure requirements that apply to registration under the Securities Act;
The SEC has not passed upon the merits of or given its approval to the securities, the
terms of the offering, or the accuracy or completeness of any offering materials;
The securities are subject to legal restrictions on transfer and resale and investors
should not assume they will be able to resell their securities; and
Investing in securities involves risk, and investors should be able to bear the loss of
their investment.
Hedge Funds, Private Equity Funds and Venture Capital Funds:
Legends: Private funds, such as hedge funds, private equity funds and
venture capital funds, would also be required to include a legend disclosing certain information:
The securities offered are not subject to the protections of the Investment Company
Act;
If performance data is included:
o performance data represents past performance;
o past performance does not guarantee future results;
o current performance may be lower or higher than the performance data presented;
o the private fund is not required by law to follow any standard methodology when
calculating and representing performance data; and
o the performance of the fund may not be directly comparable to the performance of
other private or registered funds.
Fees, Expenses and Other Information: The proposed rule would also
require the legend to identify either a telephone number or a website where an investor may

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obtain current performance data. The SEC also proposed to require private funds that include
performance data that does not reflect the deduction of fees and expenses in their written general
solicitation materials to disclose that fees and expenses have not been deducted and that if such
fees and expenses had been deducted, performance may be lower than presented.
Additional Antifraud Provisions Apply: The SEC has also proposed to
amend Rule 156 under the Securities Act, which interprets the antifraud provisions of the federal
securities laws in connection with sales literature used by investment companies, to apply to the
sales literature of private funds because it believes it is important for private funds to consider
the SECs views on the applicability of the antifraud provisions to their sales literature.
Filing of General Solicitation Materials:
As the SEC believes it will need to be aware of developments in the Rule 506 market
after the effectiveness of Rule 506(c), the SEC proposed Rule 510T to require issuers, on a
temporary basis, to submit any written general solicitation materials used in their Rule 506(c)
offerings to the SEC no later than the date of the first use of these materials. The materials would
be required to be submitted through an intake page on the SECs website. The SEC has not
proposed, at this time, that these materials would be available to the public. Compliance with
proposed Rule 510T would not be a condition of Rule 506(c). Rule 510T is proposed as a
temporary rule that will expire two years after the effective date of proposed Rule 510T.
VIII. INTEGRATION
The integration doctrine must be considered when an issuer conducts multiple offerings
in a short period of time. If applicable, multiple offerings are collapsed to determine whether a
safe harbor or exemption still applies. Under the J OBS Act, integration becomes important in
the following situations:
An issuer uses general solicitation under Rule 506(c) and a short time later
attempts to do an offering under 506(b) or Section 4(a)(2).
An issuer uses general solicitation under Rule 506(c) and also commences a
public offering within a short period of time.
Completed Rule 506(b) or Section 4(a)(2) private offerings are followed by
offerings using general solicitation under Rule 506(c) or are attempted
concurrently.
Little is known about the position the SEC will ultimately take about integration of offerings
under the J OBS Act but some clues can be gleaned from studying existing pronouncements set
forth below.

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A. Regulation D Safe Harbor
Securities Act Rule 502 provides a safe harbor for integration. All sales that are part of
the same Regulation D offering must meet all of the terms and conditions of Regulation D.
Offers and sales that are made more than six months before the start of a Regulation D offering
or are made more than six months after completion of a Regulation D offering will not be
considered part of that Regulation D offering, so long as during those six month periods there are
no offers or sales of securities by or for the issuer that are of the same or a similar class as those
offered or sold under Regulation D, other than those offers or sales of securities under an
employee benefit plan as defined in rule 405 under the Act.
If the issuer offers or sells securities for which the foregoing six-month safe harbor is
unavailable, the determination as to whether separate sales of securities are part of the same
offering (i.e., are considered integrated) depends on the particular facts and circumstances. The
following factors should be considered in determining whether offers and sales should be
integrated for purposes of the exemptions under Regulation D:
Whether the sales are part of a single plan of financing;
Whether the sales involve issuance of the same class of securities;
Whether the sales have been made at or about the same time;
Whether the same type of consideration is being received; and
Whether the sales are made for the same general purpose.
B. Concurrent Public Offerings
The filing of a registration statement may be viewed as a general solicitation of investors.
The SEC announced in August 2007 that its view is that, while there are many situations in
which the filing of a registration statement could serve as a general solicitation or general
advertising for a concurrent private offering, the filing of a registration statement does not, per
se, eliminate a companys ability to conduct a concurrent private offering, whether it is
commenced before or after the filing of the registration statement. Further, the SECs view is that
the determination as to whether the filing of the registration statement should be considered to be
a general solicitation or general advertising that would affect the availability of the Section
4(a)(2) exemption for such a concurrent unregistered offering should be based on a consideration
of whether the investors in the private placement were solicited by the registration statement or
through some other means that would otherwise not foreclose the availability of the Section
4(a)(2) exemption. This analysis should not focus exclusively on the nature of the investors, such
as whether they are qualified institutional buyers as defined in Securities Act Rule 144A or
institutional accredited investors, or the number of such investors participating in the offering;
instead, the SEC believes the companies and their counsel should analyze whether the offering is
exempt under Section 4(a)(2) on its own, including whether securities were offered and sold to
the private placement investors through the means of a general solicitation in the form of the
registration statement.

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For example, according to the SEC, if a company files a registration statement and then
seeks to offer and sell securities without registration to an investor that became interested in the
purportedly private offering by means of the registration statement, then the Section 4(2)
exemption would not be available for that offering. On the other hand, if the prospective private
placement investor became interested in the concurrent private placement through some means
other than the registration statement that did not involve a general solicitation and otherwise was
consistent with Section 4(2), such as through a substantive, pre-existing relationship with the
company or direct contact by the company or its agents outside of the public offering effort, then
the prior filing of the registration statement generally would not impact the potential availability
of the Section 4(2) exemption for that private placement and the private placement could be
conducted while the registration statement for the public offering was on file with the
Commission. The SEC also believes if the company is able to solicit interest in a concurrent
private placement by contacting prospective investors who (1) were not identified or contacted
through the marketing of the public offering and (2) did not independently contact the issuer as a
result of the general solicitation by means of the registration statement, then the private
placement could be conducted in accordance with Section 4(a)(2) while the registration
statement for a separate public offering was pending.
C. Abandoned Offerings
Rule 155 provides a non-exclusive safe harbor from integration of private and registered
offerings. Under Rule 155 a private offering of securities will not be considered part of an
offering for which the issuer later files a registration statement if:
No securities were sold in the private offering;
The issuer and any person(s) acting on its behalf terminate all offering activity in
the private offering before the issuer files the registration statement;
The preliminary and final prospectuses used in the registered offering disclose
specified information about the abandoned private offering;
The issuer does not file the registration statement until at least 30 calendar days
after termination of all offering activity in the private offering, unless the issuer
and any person acting on its behalf offered securities in the private offering only
to persons who were (or who the issuer reasonably believes were):
Accredited investors (as that term is defined in 230.501(a)); or
Persons who satisfy the knowledge and experience standard of Rule
506(b)(2)(ii).
In addition, under Rule 155, An offering for which the issuer filed a registration
statement will not be considered part of a later commenced private offering if:
No securities were sold in the registered offering;

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The issuer withdraws the registration statement in accordance with SEC rules;
Neither the issuer nor any person acting on the issuer's behalf commences the
private offering earlier than 30 calendar days after the effective date of
withdrawal of the registration statement under SEC rules;
The issuer notifies each offeree in the private offering that:
The offering is not registered under the Act;
The securities will be restricted securities (as that term is defined in
230.144(a)(3)) and may not be resold unless they are registered under the
Act or an exemption from registration is available;
Purchasers in the private offering do not have the protection of Section 11
of the Securities Act (15 U.S.C. 77k); and
A registration statement for the abandoned offering was filed and
withdrawn, specifying the effective date of the withdrawal; and
Any disclosure document used in the private offering discloses any changes in the
issuer's business or financial condition that occurred after the issuer filed the
registration statement that are material to the investment decision in the private
offering.
IX. RULE 701
Rule 701 provides for an exemption from registration for compensation plans. The rule
is available only to non-public issuers. The aggregate sales price or amount of securities sold in
reliance on this Rule during any consecutive 12-month period must not exceed the greatest of the
following:
$1,000,000;
15% of the total assets of the issuer (or of the issuers parent if the issuer is a wholly-
owned subsidiary and the securities represent obligations that the parent fully and
unconditionally guarantees), measured at the issuers most recent balance sheet date
(if no older than its last fiscal year end); or
15% of the outstanding amount of the class of securities being offered and sold in
reliance on this section, measured at the issuers most recent balance sheet date (if no
older than its last fiscal year end).
The rule exempts offers and sales of securities under a written compensatory benefit plan
established by the issuer, its parents, its majority-owned subsidiaries or majority-owned
subsidiaries of the issuers parent, for the participation of their employees, directors, general
partners, trustees (where the issuer is a business trust), officers, or consultants and advisors, and

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their family members who acquire such securities from such persons through gifts or domestic
relations orders. The rule exempts offers and sales to former employees, directors, general
partners, trustees, officers, consultants and advisors only if such persons were employed by or
providing services to the issuer at the time the securities were offered. Special rules apply to
consultants and advisers and the securities cannot be issued in connection with capital raising
transactions.
The issuer must deliver to investors a copy of the compensatory benefit plan or the
contract, as applicable. In addition, if the aggregate sales price or amount of securities sold
during any consecutive 12-month period exceeds $5 million, the issuer must deliver the
following disclosure to investors a reasonable period of time before the date of sale:
If the plan is subject to the Employee Retirement Income Security Act of 1974
(ERISA) (29 U.S.C. 1104-1107), a copy of the summary plan description required
by ERISA;
If the plan is not subject to ERISA, a summary of the material terms of the plan;
Information about the risks associated with investment in the securities sold pursuant
to the compensatory benefit plan or compensation contract;
Financial statements required to be furnished by Part F/S of Form 1-A under
Regulation A. The financial statements must be as of a date no more than 180 days
before the sale of securities in reliance on the exemption; and
If the issuer is determining plan limits by reference to its parents total assets, the
parents financial statements must be delivered.
Section 80A.46(21) of the Minnesota Statutes provides an exemption from Minnesotas blue sky
laws that can work in tandem with Rule 701. Companies that wish to use the exemption must
make a filing with the Department of Commerce at least 10 days before an issuance under the
plan.
X. EXCHANGE ACT REPORTING OBLIGATIONS
A. In General
Growing companies need to be aware of the requirements of Section 12(g) of the
Exchange Act. If the thresholds of Section 12(g) are crossed, which look principally to the
number of shareholders, the company must generally begin filing the same reports under the
Securities Exchange Act of 1934 as any company listed on the NYSE or Nasdaq. Therefore the
issue needs to be considered when raising capital and granting employees equity, and is
especially important to venture funded and other entities that use employee equity as a
significant component of compensation.
Setting aside special accommodations for bank holding companies, the J OBS Act
amended Section 12(g) and Section 15(d) of the Exchange Act as follows:

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The holders of record threshold for triggering Section 12(g) registration for
issuers (other than banks and bank holding companies) has been raised from 500
or more persons to either (1) 2,000 or more persons or (2) 500 or more persons
who are not accredited investors.
In calculating the number of holders of record for purposes of determining
whether Section 12(g) registration is required with respect to a class of equity
security, issuers (including banks and bank holding companies) may exclude
persons who received the securities pursuant to an employee compensation plan
in transactions exempted from the registration requirements of Section 5 of the
Securities Act.
As a result, we discuss the fooling critical issues in depth:
How do you count the number of holders, and do you need to look beyond the
share register?
What can an issuer do to make sure its shareholders remain accredited investors?
What is important to maintain an exemption for securities issued pursuant to an
employee benefit plan?
B. Counting Holders
While seemingly straightforward, numerous complexities can arise. Exchange Act Rule
12g5-1, which addresses the definition of held of record provides among other things, the
following counting rules:
Securities identified as held of record by a corporation, a partnership, a trust
whether or not the trustees are named, or other organization shall be included as
so held by one person.
Securities identified as held of record by one or more persons as trustees,
executors, guardians, custodians or in other fiduciary capacities with respect to a
single trust, estate or account shall be included as held of record by one person.
Securities held by two or more persons as co-owners shall be included as held by
one person.
Securities registered in substantially similar names where the issuer has reason to
believe because of the address or other indications that such names represent the
same person, may be included as held of record by one person.
Packing multiple holders into a special purpose vehicle to hold the securities and the
hoped for ability to count them as one holder probably does not work. The rule provides that
notwithstanding the foregoing points, securities held, to the knowledge of the issuer, subject to a
voting trust, deposit agreement or similar arrangement shall be included as held of record by the

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record holders of the voting trust certificates, certificates of deposit, receipts or similar evidences
of interest in such securities, provided, however, that the issuer may rely in good faith on such
information as is received in response to its request from a non-affiliated issuer of the certificates
or evidences of interest.
The SEC has confirmed in CDIs that institutional custodians, such as Cede & Co. and
other commercial depositories, are not single holders of record for purposes of the Exchange
Acts registration and periodic reporting provisions. Instead, each of the depositorys accounts
for which the securities are held is a single record holder. The SEC has also confirmed in CDIs
that securities held in street name by a broker-dealer are held of record under the rule only by the
broker-dealer. The SEC originally proposed a version of the rule that would have looked through
to the beneficial owners of the street-name securities, but adopted the rule in a form that does not
produce this result.
C. Employee Benefit Plans
It is important to understand that options and other benefit plan securities can potentially
trigger Exchange Act registration. See Exemption Of Compensatory Employee Stock Options
From Registration Under Section 12(g) Of The Securities Exchange Act Of 1934 (Release No.
34-56887). However, the SEC has confirmed in CDIs the directives in the J OBS Act that that
an issuer may exclude persons who received securities pursuant to an employee compensation
plan in Securities Act-exempt transactions whether or not the person is a current employee of the
issuer. Although Section 503 of the J OBS Act directs the Commission to adopt safe harbor
provisions that issuers can follow when determining whether holders of their securities received
the securities pursuant to an employee compensation plan in transactions that were exempt from
the registration requirements of Section 5 of the Securities Act of 1933, the lack of a safe harbor
does not affect the application of Exchange Act Section 12(g)(5).
D. Crowdfunding
The SEC has proposed in Regulation Crowdfunding, as directed by the J OBS Act, that
securities issued pursuant to the crowdfunding exemption are not counted when determining
whether Exchange Act Thresholds are crossed. The J OBS Act requires the SEC to exempt
securities issued under Section 4(a)(6) from the registration requirements of the Exchange Act.
Proposed Rule 12g-6 provides that securities issued pursuant to an offering made under Section
4(a)(6) would be permanently exempted from the record holder count under Section 12(g). An
issuer seeking to exclude a person from the record holder count would have the responsibility for
demonstrating that the securities held by the person were initially issued in an offering made
under Section 4(a)(6).
E. Practical Implications
Given the foregoing, issuers that anticipate having numerous shareholders should
consider the following:
Organizational documents should prohibit transfers to transferees that are not
accredited investors. Prior to permitting any such transfer, the issuer should

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require the proposed transferee to submit data that confirms the transferee is an
accredited investor.
Organizational documents should require accredited investors to annually
recertify that they remain accredited investors and if not perhaps a redemption
right at an agreed value should exist.
Any securities issued pursuant to benefit plans should scrupulously comply with
Securities Act exemptions and documentation of compliance should basically be
maintained forever so that the exemption from Exchange Act registration can
be proved.
Resist the urge to encourage investors to use special purpose entities to aggregate
investors to avoid Exchange Act registration but if it happens make sure there are
procedures in the special purpose entities organizational documents to maintain
exemptions as set forth above.
Have procedures to track securities issued under Regulation Crowdfunding so that
initial holders and transferees can be excluded when calculating Exchange Act
registration thresholds.
XI. USING FINDERS
Raising capital is often more difficult than anticipated for early stage companies. As a
result, early stage companies often look to a third party to identify potential investors, introduce
those potential investors to the company, and perhaps even negotiate the terms of the
investments with potential investors. Persons or entities that fulfill this role are generally
described as finders. While the use of finders may facilitate a crucial capital-raising campaign
for a company, it may also expose the company to significant risks, especially if the finder is
found to be operating as an unregistered broker-dealer.
Who is a Broker?
Section 3(a)(4) of the Exchange Act defines a broker as any person engaged in the
business of effecting transactions in securities for the account of others. However, the
Exchange Act fails to define effecting transaction or engaged in the business, which has led
to the development of a variety of factors that must be analyzed to determine whether a person
falls within the definition of a broker.
19
Traditionally, the most common factors that are
analyzed are whether the person (1) works as an employee of the issuer, (2) receives a
commission rather than a salary, (3) sells or earlier sold the securities of another issuer, (4)
participates in negotiations between the issuer and an investor, (5) provides either advice or a

19
See SEC v. Kramer, 778 F. Supp. 2d 1320, 1334 (M.D. Fla. 2011).

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valuation as to the merit of an investment, and (6) actively (rather than passively) finds
investors.
20

Because of the multi-factor test, the broker definition includes persons engaging in
activities that are only incidental to the actual purchase and sale of securities, such as providing
advice regarding securities valuations, locating investors or issuers, soliciting new clients,
assisting in the structuring of securities transactions, and disseminating purchase quotes.
Moreover, the differences between a finder and a broker have not been well developed in case
law and no-action letters, leaving the outcome dependent upon the facts and circumstances of
each particular arrangement.
21
As a result, there is a substantial risk that a finder may not know
that he or she is engaging in conduct that requires registration as a broker-dealer.
Transaction-Based Compensation:
Over time, the SECs interpretation of the broker definition has shifted somewhat to place
more emphasis on the receipt of transaction-based compensation. In a 2010 no-action letter
issued to Brumberg, Mackey & Wall, P.L.C. (the Mackey no-action letter), the SEC called the
receipt of transaction-based compensation a hallmark of broker-dealer activity and indicated
its position that any person receiving transaction-based compensation in connection with
another persons purchase or sale of securities typically must register as a broker-dealer or be an
associated person of a registered broker-dealer.
22

Unfortunately, the SECs analysis is not always as clear as it appeared to be in the
Mackey no-action letter. In a series of releases from December 6, 2012, the SEC found three
different individuals had violated Section 15(c) of the Exchange Act in connection with the
offerings by an issuer accused of running a Ponzi scheme in the Pacific Northwest. The finders
had violated Section 15(c) of the Exchange Act by serving as a broker without being associated
with a registered broker-dealer. In each case, the involvement of the finders followed a typical
pattern. The finders located investors, supplied them with copies of offering and marketing
materials, answered questions, discussed the nature of the investment opportunity with them,
and, importantly, received transaction-based compensation for their efforts.
23
It is unclear from
the litigation releases, however, just how much weight the SEC placed on the receipt by the
finders of transaction-based compensation.
Courts and the Kramer Standard:
Federal Courts differ from the SEC in their approach to analyzing whether a finder is an
unregistered broker, as exemplified by the 2011 decision of SEC v. Kramer.
24
As discussed

20
Id.
21
SEC v. Kramer, 778 F. Supp. 2d 1320, 1336-1337 (M.D. Fla. 2011).
22
Brumberg, Mackey & Wall, P.L.C., SEC No-Action Letter (May 17, 2010).
23
See Exchange Act Release No. 68369, In the Matter of Benjamin R. Daniels, December 6, 2012; Exchange Act
Release No. 68370, In the Matter of Stephen Persad, December 6, 2012; Exchange Act Release No. 68371, In the
Matter of Dominic ODierno, December 6, 2012.
24
778 F. Supp. 2d 1320 (M. D. Fl. 2011).

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above, the SECs approach to determining whether finders were acting as brokers has placed
emphasis on whether the finder received transaction based compensation (although more recent
enforcement actions do not make this explicit). In Kramer, however, the court took a broader
approach, relying on the traditional multi-factor analysis rather than focusing on the single factor
of transaction-based compensation.
In Kramer, Kenneth Kramer introduced a registered broker named Talib to a company
called Skyway Aircraft that was seeking to raise capital. Talib eventually raised more than $14
million for Skyway, and Kramer was paid nearly $400,000 as compensation for introducing
Talib to Skyway. Although he was not expressly employed by Skyway, Kramer continued to act
as a company cheerleader. He purchased shares, monitored company news and requested press
releases, and encouraged others to read the press releases. He directed some of his friends and
family to the Skyway website and indicated to them that he thought Skyway was a good
company and that an investment in Skyway was a good deal. A number of the people whom
Kramer talked to about Skyway eventually purchased shares through registered broker-dealers,
and some of this first tier of purchasers also recommended Skyway to their acquaintances,
resulting in a second tier of purchases of Skyway shares by people unknown to Kramer. Skyway
eventually asked Kramer to provide a list of all of these purchases and offered to pay Kramer by
issuing him shares of Skyway equal to 20% of the shares purchased.
According to the court, although Kramer received transaction-based compensation on
two occasions, that single factor alone was not enough to classify Kramer as a broker-dealer.
With regard to the evidence apart from Kramers receipt of transaction based compensation, the
court pointed out typical broker-dealer conduct that the SEC had not been able to prove with
respect to Kramer and implied that the absence of these other indications of broker-dealer
conduct weighed in favor of Kramer. For example, the court noted that Kramer never: (1) sold a
share of Skyway; (2) participated in the purchase and sale of a Skyway security; (2) provided
advice or other information about the investment; (3) advertised or distributed promotional
material for Skyway; (4) sponsored a seminar or social event at which Kramer promoted
Skyway; (5) sold the security of another issuer; (6) hired employees to contact potential investors
about Skyway; (7) called a potential investor other than his small group of friends and family; or
(8) encouraged a broker to sell Skyway securities.
The Kramer court also expressly questioned the SECs interpretation of the broker test,
noting that the [SEC]s proposed single-factor transaction-based compensation test for broker
activity (i.e., a person engaged in the business of effecting transactions in securities for the
accounts of others) is an inaccurate statement of the law.
25
The court also resisted attempts by
the SEC to rely on no-action letters, reminding the SEC that a no-action letter is informal and
possesses no binding legal authority.
26
The Kramer court sought to emphasize that the
consideration of whether a finder is acting as a broker-dealer is a complicated, multi-factor, case-
by-case analysis.

25
SEC v. Kramer, 778 F. Supp. 2d 1320, 1341 n.54 (M.D. Fla. 2011).
26
Id., at 1336 n.50.

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Kramer was appealed by the SEC, and its still possible that the decision could be
overturned. Based on the context of the SEC action, Kenneth Kramer does not appear to be an
unsophisticated citizen without knowledge that he may have been violating securities laws.
Kramer had past experience as the head of a company engaged in the sale of municipal bonds
and was the co-owner of a company that sold London Commodity Options before their sale was
prohibited by Congress. In 1988, Kramer pled guilty to wire fraud and served 28 months in
prison. After Skyway went bankrupt, the SEC initiated a suit against six defendants, including
Kramer and his partner, Baker. Although Kramer and Baker were only charged with operating
as unregistered brokers, the other defendants were charged with violating anti-fraud provisions
relating to an alleged pump-and-dump scheme, whereby numerous material misrepresentations
and omissions were made in offering materials and statements to investors in order to inflate the
share prices before Company insiders disposed of their shares at the artificially high price. The
SEC obtained default or consent judgments against all of the defendants except Kramer.
Examples of SEC No-Action Letters
On May 17, 2010, the SEC denied a no-action request submitted by the law firm of
Brumberg, Mackay & Wall, P.L.C. The law firm stated it would make introductions to persons
who may have an interest in providing financing to an issuer. The issuer would pay a percentage
of the gross amount raised as a result of the introductions. The SEC staff denied the request
because it believed that the introductions resulted in a pre-screening to determine eligibility to
purchase securities and pre-selling the securities to gauge interest. The receipt of the transaction
based compensation would give the law firm a salesmans stake in the business and create a
heightened incentive to engage in sales efforts. As a result, under SEC rules, the proposed
activities would require broker-dealer registration.
On May 7, 2001, the SEC issued a partial denial of a no action request to 1
st
Global, Inc.
A registered broker dealer subsidiary of 1
st
Global proposed to engage CPAs as registered
representatives. Many of the CPAs were partners or shareholders in CPA firms and not all
partners in the CPA firm were expected to be registered representatives of a broker-dealer.
Many of the CPAs had entered into agreements requiring them to account to the firm for
revenues generated by firm clients.
The SEC stated it would not recommend enforcement action if 1
st
Global paid
commissions directly to a CPA registered representative so long as the registered representative
was not subject to any formal or informal agreement or arrangement directing him or her to turn
over securities commissions to an unregistered CPA firm. This meant that the CPA could not
forward securities commissions to the CPA firm under any other title or label.
The SEC stated that it could not assure it would not recommend enforcement action if the
registered CPA voluntarily turned over commissions to the CPA firm, either on a voluntary or
required basis, because that would give the CPA firm a financial stake in the revenues generated
by the registered representative at the same time the CPA firm was in a position to influence the
registered representatives actions and to direct customers to the registered representative.

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The SEC also stated that it could not assure that, under any circumstances, it would not
recommend enforcement action if 1
st
Global paid securities commissions to a registered broker-
dealer, in which a 1
st
Global registered representative is dually registered, when that other
broker-dealer was owned by an unregistered CPA firm or its partners. The SEC noted that its
analysis was highly fact specific and that under some circumstances the unregistered CPA firm
or its partners could exercise such a degree of control over the activities of the broker-dealer or
its registered representatives that the unregistered CPA firm itself could be found to have
engaged in broker-dealer activity.
The same issue arises for M&A advisory firms that earn a transaction fee based on the
sale of stock. However the SEC has provided for some relief in connection with the sale of a
private company. In a J anuary 31, 2014 no-action letter, the SEC indicated that, under certain
circumstances, an M&A broker can receive transaction-based compensation without having to
register as a broker-dealer. The J anuary 31st no-action letter defines M&A Broker to mean a
person engaged in the business of effecting securities transactions solely in connection with the
change in control of privately held companies to buyers that will actively operate the businesses
after the transactions close. Persons who satisfy this definition can receive transaction-based
compensation without registering as broker-dealers provided that the transaction and their
involvement in the transaction comply with a number of conditions set forth in the no-action
letter.
Examples of SEC Enforcement Action
On March 11, 2013, the SEC announced charges against New York-based private equity
firm Ranieri Partners, a former senior executive, and an unregistered broker who violated
securities laws when soliciting more than $500 million in capital commitments for private funds
managed by the firm.
An SEC investigation found that William M. Stephens of Hinsdale, Ill., solicited
investors as a hired consultant for Ranieri Partners and was paid fees by the firm, but never
registered as a broker. Stephens longtime friend Donald W. Phillips, a senior managing director
who headed up capital raising efforts for Ranieri Partners, was responsible for overseeing
Stephens activities as a purported finder who would merely make initial introductions to
potential investors. But Stephens role went far beyond that of a finder. He consistently
communicated with prospective investors and their advisors and provided them with key
investment documentation that he received from Ranieri Partners.
According to the SECs orders instituting settled administrative and cease-and-desist
proceedings, Stephens engaged in the business of effecting transactions in securities in several
ways despite not being registered as a broker or affiliated with a registered broker-dealer.
Stephens sent private placement memoranda, subscription documents, and due diligence
materials to potential investors, and urged at least one investor to consider adjusting portfolio
allocations to accommodate an investment with Ranieri Partners. Stephens provided potential
investors with his analysis of the strategy and performance track record for Ranieri Partners
funds, and also provided confidential information identifying other investors and their capital
commitments.

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The SECs order against Phillips and Ranieri Partners found that Phillips, who lives in
Barrington, Ill., aided and abetted Stephens violations by providing Stephens with key fund
documents and information while ignoring red flags indicating that Stephens had gone well
beyond the limited role of a finder and was actively soliciting investments. The order found that
Ranieri Partners caused Stephens violations.
In settling the SECs charges, Ranieri Partners agreed to pay a penalty of $375,000,
Phillips agreed to pay a penalty of $75,000, and Stephens agreed to be barred from the securities
industry. The SECs orders require each of them to cease-and-desist from further violations of
Section 15(a). The SEC also suspended Phillips from acting in a supervisory capacity at an
investment adviser or broker-dealer for nine months. Ranieri Partners, Phillips and Stephens
consented to the entry of the SECs orders without admitting or denying the findings.
While the fines imposed on Ranieri Partners and Phillips are not insignificant, they pale
in comparison to the $22 million fine imposed upon Behrooz Sarafraz pursuant to a May 15,
2014 settlement with the SEC. Sarafraz is alleged to have sold millions of dollars in oil and gas
investments, on a commission basis, without being registered as a broker-dealer or associated
with a registered broker-dealer. The $22 million figure consists primarily of disgorgement of
profits and pre-judgment interest.
A loose association of a finder with a broker-dealer does not solve the problem and is
likely to get the broker-dealer in trouble as well. In a May 15, 2014 order, the SEC took
enforcement action against Rafferty Capital Markets, a registered broker, as a result of Raffertys
execution of about 100 trades in conjunction with an unregistered entity not named in the order.
Rafferty and the unregistered entity had agreed that certain of the unregistered entitys personnel
would become registered representatives of Rafferty and then trades would be executed under
the aegis of Raffertys registration, but the unregistered entity would manage the business itself.
Although five of the unregistered entitys personnel did, in fact, become registered
representatives of Rafferty, the unregistered entity controlled and directed the work of the five
representatives. In a press release announcing the order, the SEC explained that Rafferty had
no involvement in the trading or compensation decisions while the registered representatives
executed the trades through Raffertys systems on behalf of the unregistered firm. The SEC
found that Rafferty had violated record keeping rules relating to the activities of the employees
of the unregistered entity and fined Rafferty about $850,000. While the enforcement action
focused on the broker-dealer and not on the unregistered representatives, it demonstrates that
issuers should be on the alert for loose affiliates that do not satisfy the broker-dealer rules.
Consequences of Hiring an Unregistered Broker
Section 15(a)(1) of the Exchange Act makes it unlawful for a person to effect transactions
in, or induce or attempt to induce the purchase or sale of, securities without registering with the
SEC as a broker-dealer. The risks that companies become exposed to when they used finders
include both risks relating to the use of a finder that should be, but is not, registered as a broker-
dealer, as well as risks relating to the conduct of the finder generally, regardless of the finders
registration status. These risks include:

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Rescission Rights:
Section 29(b) of the Exchange Act provides that a contract is void as regards any person
who engages in the performance of the contract in violation of any provision of the Exchange
Act or related rules. Section 29(b) would apply to a transaction involving an unregistered
broker-dealer, and could require the unregistered broker-dealer to return commissions and fees
earned. Section 29(b) also provides for investor rescission rights that expire on the earlier of the
three year anniversary of the issuance of the securities or the one year anniversary of the
discovery of the fraud. It is unclear, however, whether rescission rights would be applicable to
an unregistered broker-dealer. As the ABA noted in an influential 2005 report,
27
Section 29(b)
has never actually been applied in this way, perhaps because actions involving unregistered
broker-dealers are usually quickly settled, with the unregistered broker-dealer often agreeing to
return funds to investors. Until there is a definitively litigated case in which Section 29(b) is
applied to require an unregistered broker-dealer to honor rescission rights, we will not know the
exact scope of the statutes reach as applied to unregistered broker-dealers. For now, it appears
that the threat of such application is enough to provide a strong incentive to settle.
10b-5 Liability:
In some instances, use of a finder who is an unregistered broker-dealer in connection with
a private offering could result in fraud liability for the principals of the business pursuant to Rule
10b-5 under the Exchange Act. For example, in 2008 the SEC filed securities fraud charges
against W.P. Carey & Co. and two of its senior executives relating to a number of alleged
violations of securities laws, including the failure to disclose in offering documents nearly $10
million in compensation paid to broker-dealers.
28
All of the charges were settled, resulting in the
payment of multi-million dollar fines, disgorgement of proceeds, and a five year ban preventing
the companys former Chief Financial Officer from serving as an officer or director of a public
company. It is impossible to determine, however, what portion of the cost of the settlement can
be directly linked to the broker-dealer compensation disclosure problems.
Aiding and Abetting Liability:
A company that utilizes an unregistered broker-dealer could also be subject to liability
under Section 20(e) of the Exchange Act for aiding and abetting the unregistered broker-dealers
violation of the registration requirements.
Blue Sky Issues
The employment by an issuer of a finder can also have ramifications for state blue sky
filings. The current version of Form D, required to be filed in connection with all Regulation D
offerings, requires separate disclosure of compensation paid to brokers and to finders. As a

27
Mary M. Sjoquis, Report and Recommendations of the Task Force in Private Placement Broker-Dealers, A.B.A.
Sec. of Bus. Law (J une 20, 2005).
28
Exchange Act Release No. 20501, SEC Charges W.P. Carey and Two Senior Executives in Fraudulent Payment
Scheme, March 18, 2008.

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result, the presence of disclosure of compensation paid to finders on a Form D could cause a
state to investigate an offering more closely.
Whether a finder is required to be registered as a broker-dealer or not, the use of a finder
also exposes the Company to the risk that it will lose an exemption from registration
requirements for the offering as a result of actions by the finder. For example, the finder could
engage in conduct prohibited by Regulation D, such as general solicitation of investors, which
could then cause the company to lose its ability to rely on Regulation D in connection with its
private offering. In addition, one of the conditions of the Minnesota intra-state offering
exemption is that a commission or other remuneration is not paid or given, directly or
indirectly, to a person other than a broker-dealer registered under this chapter or an agent
registered under this chapter.
29

Direct Regulation of Finders in Minnesota
Aside from the risk that finders may engage in activities that require registration as a
broker-dealer under federal law, the laws of some states, including Minnesota, directly regulate
the activities of finders and require finders to register with the state. Section 80A.57 makes it
illegal for a finder to transact business in the state, and for an issuer to employ or associate
with a finder, unless the finder has registered with the state or is exempt from registration. The
exemptions from registration are of limited utility for example, a finder is exempt from
registration if the finder limits participation in the offering to performing clerical or
administrative acts. In addition, the exemptions specifically do not apply to finders who receive
transaction-based compensation in connection with Regulation D offerings.
30

XII. TENDER OFFERS
It comes as a surprise to many that tender offers for non-exchange traded securities must
comply with the SEC anti-fraud rules for tender offers. Rule 14E, which is generally applicable
to all tender offers, including those related to private companies, requires among other things that
the tender offer be open for at least 20 business days and that the subject company must either
recommend acceptance or rejection of the tender offer, express no opinion and remain neutral or
state it is unable to take a position.
The term tender offer is not defined by statute, regulation, or in federal securities case
law. Congress, in passing the Williams Act, left the definition of tender offer open, so that
courts could determine the meaning of the term on a case-by-case basis.
The courts have applied various tests for determining whether a particular solicitation is a
tender offer. Leading commentators on securities law have concluded, [n]o single principle
emerges from the [leading tender offer] cases which would permit their reconciliation.

29
MINN. STAT. 80A.46(14).
30
See MINN. STAT. 80A.57(b)(5).

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The test applied in the vast majority of the tender offer cases is the Wellman-Hanson test.
This test is a synthesis of the reasoning applied in two cases: Wellman v. Dickinson and Hanson
Trust PLC v. SCM Corporation. In Wellman v. Dickinson, the federal district court for the
Southern District of New York set forth the following characteristics of tender offers:
(1) there is an active and widespread solicitation of public shareholders;
(2) a solicitation is made for a substantial percentage of the targets shares;
(3) an offer to purchase is made at a premium over the prevailing market price;
(4) the terms of the offer are firm rather than negotiable;
(5) the offer is contingent on the tender of a fixed number of shares, often subject to a
fixed maximum number of shares to be purchased;
(6) the offer is open for only a limited time;
(7) the offerees are subject to pressure to sell their shares; and
(8) the public announcement of a purchasing program precedes or accompanies rapid
accumulation of the targets shares.
With respect to the above factors, the Wellman court and the courts applying the Wellman
courts analysis have concluded that there is no one factor, or combination of factors, that is
determinative of whether a particular solicitation is a tender offer. The presence or absence of
one or more of the eight factors may be outweighed by the presence or absence of one or more of
the eight factors that is or are more compelling or determinative.
In Hanson Trust PLC v. SCM Corporation, the U.S. Court of Appeals for the Second
Circuit cautioned against looking to the Wellman factors as a litmus test for determining
whether a particular solicitation is a tender offer. In Hanson, the Second Circuit looked to the
statutory purpose of the Williams Act to protect ill-informed solicitees and focused on
whether, given the totality of the circumstances of the solicitation in question, there is a
substantial risk that solicitees will lack information needed to make a carefully considered
appraisal of the proposal put before them. Hanson had the effect of elevating the solicitees
access to information as a super factor to offset otherwise relevant Wellman factors.
The Wellman-Hanson test is a totality of the circumstances type of test. At least one
court has described the Wellman-Hanson test as one of loosely guided discretion.
XIII. FOREIGN CORRUPT PRACTICES ACT
In addition to being applicable to U.S. public companies, the anti-bribery provisions of
the Foreign Corrupt Practices Act, or FCPA, apply to domestic concerns. A domestic
concern is generally any business form (e.g., private corporations, limited liability companies,
partnerships, sole proprietorships) with a principal place of business in the U.S. or organized

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under U.S. law. A domestic concern also includes any individual who is a citizen, national,
or resident of the U.S.
The FCPA can reach conduct that occurs entirely outside the United States by foreign
subsidiaries. Prosecutors may seek to hold the parent company liable under various theories.
Prosecutors may argue:
The subsidiary is an alter ego of the parent.
The parent and the subsidiary are a single integrated business enterprise.
Actions of employees of a foreign subsidiary should be attributed to the parent
under the doctrine of respondeat superior.
Private companies with significant overseas operations that are seeking to be acquired
should be aware that acquirors will often perform significant FCPA due diligence as part of the
acquisition process.
It would be a mistake to assume that improper payments need to be large to attract the
attention of a prosecutor, as illustrated by the Smith & Wesson case. During the period in
question, Smith & Wessons international business was in its developing stages and accounted
for approximately 10% of the companys revenues. According to the SEC, Smith & Wesson
retained a third-party agent in Pakistan to assist the company in obtaining a deal to sell firearms
to a Pakistani police department. The SEC further alleged that even after the agent notified the
company that he would be providing guns valued in excess of $11,000 to Pakistani police
officials in order to obtain the deal, and that he would be making additional cash payments to the
officials, the company authorized the agent to proceed with the deal. The SEC believes Smith &
Wessons Vice President of International Sales and its Regional Director of International Sales
authorized the sale of the guns to the agent to be used as improper gifts and authorized payment
of the commissions to the agent, while knowing or consciously disregarding the fact that the
agent would be providing the guns and part of his commissions to Pakistani officials as an
inducement for them to award the tender to the company. Smith & Wesson ultimately sold 548
pistols to the Pakistani police for $210,980 and profited from the alleged corrupt deal in the
amount of $107,852. The SEC also alleged a couple of instances of attempted bribes but the
related business never materialized. While Smith & Wesson did not admit the SECs allegations,
among other things it agreed to pay a civil penalty of over $2 million.
XIV. WHISTLEBLOWERS
Employees of closely held businesses can in appropriate circumstances provide
whistleblowing submissions to the SEC in hopes of receiving a monetary reward and avail
themselves to the whistleblower anti-retaliation protections.
SEC Rule 21F-2 defines a whistleblower as any natural person that, alone or jointly
with others, provides the SEC with information pursuant to the procedures described in the SEC
rules, and the information relates to a possible violation of the federal securities laws (including
any rules or regulations thereunder) that has occurred, is ongoing, or is about to occur.

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That same rule provides that, for purposes of the anti-retaliation protections afforded by
Section 21F(h)(1) of the Exchange Act, a person is a whistleblower if:
The person possesses a reasonable belief that the information provided relates to a
possible securities law violation that has occurred, is ongoing, or is about to
occur, and;
The person provides that information in a manner described in Section
21F(h)(1)(A) of the Exchange Act.
Section 21F(h)(1)(A) of the Exchange Act provides that no employer may discharge,
demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate
against, a whistleblower in the terms and conditions of employment because of any lawful act
done by the whistleblower:
in providing information to the SEC in accordance with this section;
in initiating, testifying in, or assisting in any investigation or judicial or
administrative action of the SEC based upon or related to such information; or
in making disclosures that are required or protected under the Sarbanes-Oxley Act
of 2002, the Securities Exchange Act of 1934 and any other law, rule, or
regulation subject to the jurisdiction of the SEC.
XV. INVESTMENT COMPANIES
When entities are formed for the purposes of holding a pool of securities, issues under the
Investment Company Act of 1940 must be considered. An investment company means an
issuer which:
is or holds itself out as being engaged primarily, or proposes to engage primarily, in
the business of investing, reinvesting, or trading in securities;
is engaged or proposes to engage in the business of issuing face-amount certificates
of the installment type, or has been engaged in such business and has any such
certificate outstanding; or
is engaged or proposes to engage in the business of investing, reinvesting, owning,
holding, or trading in securities, and owns or proposes to acquire investment
securities having a value exceeding 40 per centum of the value of such issuers total
assets (exclusive of government securities and cash items) on an unconsolidated
basis.
Investment securities includes all securities except (A) government securities,
(B) securities issued by employees securities companies, and (C) securities issued by majority-
owned subsidiaries of the owner which (i) are not investment companies, and (ii) are not relying
on the exception from the definition of investment company in Section 3(c)(1) or (7) of the
Investment Company Act.

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There are a number of exceptions from regulation as an investment company. Section
3(c)(1) exempts any issuer whose outstanding securities (other than short- term paper) are
beneficially owned by not more than one hundred persons and which is not making and does not
presently propose to make a public offering of its securities. Section 3(c)(7) exempts any issuer,
the outstanding securities of which are owned exclusively by persons who, at the time of
acquisition of such securities, are qualified purchasers, and which is not making and does not
at that time propose to make a public offering of such securities. Qualified purchasers are
defined to include (i) any natural person who owns not less than $5,000,000 in investments, as
defined by the SEC and (ii) any company that owns not less than $5,000,000 in investments and
that is owned directly or indirectly by or for two or more natural persons who are related as
siblings or spouse (including former spouses), or direct lineal descendants by birth or adoption,
spouses of such persons, the estates of such persons, or foundations, charitable organizations, or
trusts established by or for the benefit of such persons.
XVI. INVESTMENT ADVISERS
The Dodd-Frank Act and related SEC rulemaking eliminated the Federal exemption from
registration as an investment adviser for advisers with fewer than 15 clients. This makes
understanding the definition of investment adviser more important because of the lack of a de
minimis client exclusion.
The Investment Advisers Act of 1940 defines an investment adviser to be any person
who:
for compensation,
engages in the business of advising others, either directly or through publications
or writings,
as to the value of securities or as to the advisability of investing in, purchasing, or
selling securities,
or who, for compensation and as part of a regular business, issues or promulgates
analyses or reports concerning securities.
In certain circumstances closely held businesses that help family members manage their
finances may be able to rely on the family office exception from the investment adviser rules
contained in Rule 202(a)(11)(G)-1. In general that exception is available to any company that:
provides investment advice only to family clients, as defined by the rule,
is wholly owned by family clients and is exclusively controlled by family
members and/or family entities, as defined by the rule, and
does not hold itself out to the public as an investment adviser.

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