Regulation D, Rule 504/SCOR Filing

April 13, 2006

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When raising money for the business, various securities law issues may come into play. You'll need to follow the rules carefully in order to preserve limited liability under the law.

If a small business owner is interested in raising capital from the public by issuing securities, a federal Regulation D, Rule 504 exemption coupled with a uniform state small corporate offering registration (SCOR) filing will be the most common route taken. Both the federal exemption and the state filing limit the amount raised to $1 million in a one-year period. To prevent abuse, a second offering cannot be made for six months after the first 12 months expire. Effectively, the small business owner could rely on this combination to raise $1 million every 18 months.

In addition, there is another option called Regulation A, subject to a different set of rules, but it allows a business to "test the waters" for interest before undertaking more formal filing actions.

Unlike other federal exemptions, the Rule 504 exemption contains no onerous restrictions (other than the $1 million limitation). The issuer is free to advertise the securities and to solicit potential investors. In addition, there are no restrictions on the number or type of investors. Nor are there any resale restrictions on the securities. The SEC requires that Form D be filed after the first sale, notifying the SEC that the issuer has used the exemption. However, it is wise to file this form prior to offering the securities for sale, in case the SEC has any questions related to registration and exemption, and refrain from any advertisements, offers or sales until the SEC approves the form.

Work Smart

Until recently, some small businesses used the federal Rule 504 exemption, and then sold securities only in those states that offered a similar exemption without any onerous restrictions.

However, the intent of Rule 504 has always been that the issuer registers the securities in each state in which they are offered for sale and comply with the strict registration requirements imposed by the states. This is why under Rule 504, the issuer faces no real federal restrictions related to the sale.

Accordingly, the SEC amended Rule 504 to effectively limit the use of Rule 504 only to those offerings made in states where registration is required or is exempt only with severe restrictions, such as bans on general advertising of the securities, limits on the numbers and types of investors, etc. The result is that, today, an issuer who wants to raise capital from the public through a general solicitation, and rely on Rule 504, will have to register the securities in the states through a SCOR filing.

The state SCOR filing is an actual registration, rather than an exemption. But unlike other aspects of state securities laws, the form used is uniform, meaning that one form can be completed and submitted to each state, with a few minor exceptions.

Warning

While nearly all states accept the SCOR filing, the following states do not accept it, at this time:

Alabama
Delaware
Florida
Hawaii
Kentucky
New York

Moreover, the SCOR registration, while uniform in appearance, will not be treated identically when it reaches the individual states.

Most states are "merit-review" states. They review the offering to determine whether it is "fair" to investors. However, the following states, do not conduct a merit review:

Connecticut
Georgia
Illinois
Maryland
New Jersey
New York
Vermont
Washington

In these non-merit-review states, the offering will automatically be approved, provided all of the information on the forms is complete and accurate. Note that "non-merit review" is also the policy embodied in federal securities law.

In the merit-review states, if the regulators believe the offering is not fair to investors, they will not approve it. The following merit-review states have a reputation as being hostile toward SCOR filings:

California
Massachusetts
Texas

The following merit-review states have a reputation as being progressive toward SCOR filings:

Arizona
South Carolina
Iowa
Washington

The small business owner making a public offering of securities may want to consider offering the securities only in the non-merit-review states and the merit-review states with a progressive stance toward SCOR offerings (remember, however, that New York does not accept a SCOR registration at this time; a filing there will have to made on the state's individual registration form).

In particular, it may be advisable to forego an offering in those states perceived as being hostile toward the SCOR registration.