Friday, September 25, 2009


Recently, Cosgrove Law members attended the North American Securities Administrators (NASAA) annual conference in Denver. One of the topics presented focused on the hotly contested issue of Rule 506 transactions.

The Securities and Exchange Commission, in response to criticism that compliance with federal securities laws disadvantages small business, promulgated Regulation D. Rule 506 is one of the rules created and provides an exemption from registration under Section 4(2) of the 1933 Act. This exemption is the most frequently used exemption from Regulation D. Rule 506 limits the number of purchasers to 35, but there is no limit on the number of offerees. In determining the total number of purchasers, an offeror can exclude the same classes of accredited investors and related persons/entities as in Rule 505. However, unlike the other provisions in Regulation D, Rule 506 does not cap the cumulative amount of offered securities. Most states have a corollary provision to Rule 506 in their state securities laws that includes the same or similar exemption.

Ultimately, Regulation D is intended to simplify, clarify, and expand the already existing limited offering exemptions from registration. These regulations are also supposed to facilitate uniformity between state and federal exemptions, which would effectively level the playing field for costs of raising capital in small business. In 1996, Congress passed the National Securities Markets Improvement Act of 1996 (NSMIA) to further promote uniformity.

However, some argue that this legislation is a federal attempt to preempt state legislation and actually poses a threat to investors’ state law protections. To support their argument, proponents specifically claim the NSMIA effectively restrains state regulators’ authority and ability to oversee securities markets, especially Rule 506 transactions because covered securities are no longer subject to substantive state review. As such, state regulators are having a more difficult time catching early-stage fraud.

Others argue that despite the NSMIA, states still have enough regulatory and oversight authority for securities transactions under Rule 506 exemptions. They note that NSMIA permits states to require filings and fees for the offer and sale of covered securities in their state. Furthermore, because the NSMIA only preempts state securities registration requirements, states still can impose requirements on broker-dealer registration, which allows states to examine whether action is required in connection with a particular offer or transaction. Therefore, although covered securities are not subject to state law review, states still have authority under blue-sky laws to oversee offerings involving covered securities.

Following the wake of several financial scandals recently, there has been a push for reform, so undoubtedly, this debate will continue.

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