[Federal Register Volume 64, Number 44 (Monday, March 8, 1999)]
[Rules and Regulations]
[Pages 11090-11094]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-5295]



[[Page 11089]]

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Part II





Securities and Exchange Commission





_______________________________________________________________________



17 CFR Part 230, et al.



Revision of Rule 504 of Regulation D, the ``Seed Capital'' Exemption; 
Rule 701--Exempt Offerings Pursuant to Compensatory Arrangements; 
Registration of Securities on Form S-8; Final Rules



Registration of Securities on Form S-8; Publication or Submission of 
Quotations Without Specified Information; Proposed Rules

  Federal Register / Vol. 64, No. 44 / Monday, March 8, 1999 / Rules 
and Regulations  

[[Page 11090]]



SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 230

[Release No. 33-7644; S7-14-98]
RIN 3235-AH35


Revision of Rule 504 of Regulation D, the ``Seed Capital'' 
Exemption

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``we'' or 
``Commission'') is adopting amendments to Rule 504 of Regulation D, 
which provides an exemption from Securities Act registration for 
securities offerings of non-reporting companies that do not exceed an 
aggregate annual amount of $1 million. Recent fraudulent secondary 
transactions in the over-the-counter markets of ``microcap'' companies 
have involved freely tradable securities issued in Rule 504 offerings. 
To curb these abuses, we are modifying Rule 504 to limit the 
circumstances where general solicitation is permitted and ``freely 
tradable'' securities may be issued in reliance on the rule to 
transactions registered under state law requiring public filing and 
delivery of a disclosure document to investors before sale, or exempted 
under state law permitting general solicitation and advertising so long 
as sales are made only to accredited investors. Since most transactions 
under Rule 504 are private ones, they will continue to be permissible 
under the exemption, but general solicitation and advertising will not 
be permitted and the securities will be ``restricted.''

EFFECTIVE DATE: April 7, 1999.

FOR FURTHER INFORMATION CONTACT: Richard K. Wulff or Barbara C. Jacobs 
(202-942-2950), Office of Small Business, Division of Corporation 
Finance, Securities and Exchange Commission, 450 Fifth Street, NW, 
Washington, DC 20549.

SUPPLEMENTARY INFORMATION:

I. Executive Summary and Background

    Congress has passed significant legislation to aid small businesses 
in raising capital in the private and public securities markets over 
the years. The Small Business Investment Incentive Act of 1980, for 
example, was designed to reduce the regulatory restraints on small 
business capital formation.\1\ In response to that Act, in 1982, we 
adopted Regulation D \2\ under the Securities Act of 1933 (``Securities 
Act'').\3\ Regulation D is an exemption from Securities Act 
registration that was designed to:
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    \1\ Pub. L. No. 96-477, 944 Stat. 2275. That Act amended the 
Securities Act by adding Section 4(6) [15 U.S.C. 77(d)(6)], which 
among other matters, exempts from registration offers or sales of 
securities in the aggregate amount of $5 million or less if solely 
made to ``accredited investors''.
    \2\ 17 CFR 230.501 et seq. See Release No. 33-6389 (March 8, 
1982) [47 FR 11251].
    \3\ 15 U.S.C. 77a et seq.
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     Simplify existing rules and regulations;
     Eliminate any unnecessary restrictions that those rules 
and regulations placed on issuers, particularly small businesses; and
     Achieve uniformity between state and federal exemptions in 
order to facilitate capital formation consistent with the protection of 
investors.\4\
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    \4\ See Release No. 33-6389 at Section II.A.
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    Regulation D provides exemptions from Securities Act registration 
for securities offerings under three separate rules: Rules 504, 505 and 
506.\5\ Rule 504 is the limited offering exemption designed to aid 
small businesses raising ``seed capital.'' Currently, Rule 504 permits 
a non-reporting issuer \6\ to offer and sell securities to an unlimited 
number of persons without regard to their sophistication or experience 
and without delivery of any specified information in a public 
offering.\7\ General solicitation and general advertising are permitted 
for all Rule 504 offerings. The aggregate offering price of this 
exemption is limited to $1 million in any 12-month period; and certain 
other offerings must be aggregated with the Rule 504 offering in 
determining the available sales amount.\8\ Securities sold under this 
exemption may be resold freely by non-affiliates of the issuer \9\ who 
are not otherwise acting as an underwriter.\10\
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    \5\ Rules 504 and 505 are dedicated to the needs of small 
issuers; they are based on our authority under Section 3(b) of the 
Securities Act [15 U.S.C. 77(b)], which permits us to create 
exemptions where the aggregate amount of the offering does not 
exceed $5 million. In 1996, Section 28 was added to the Securities 
Act [15 U.S.C. 78bb], which gives us broad general exemptive 
authority without dollar limit. In a companion release, we are 
adopting amendments to Rule 701 of the Securities Act [17 CFR 
230.701] pursuant to this new authority. See Release No. 33-7645.
    Rule 505 is designed to help small businesses because it permits 
sales to a small number of nonaccredited, unsophisticated investors. 
Rule 506 is our non-exclusive safe harbor rule adopted under the 
``non-public'' offering exemption of Section 4(2) of the Securities 
Act [15 U.S.C. 77d(2)]. It permits sales only to accredited 
investors and a limited number of sophisticated investors.
    \6\ A non-reporting issuer is an issuer that is not required to 
file reports with the Commission under Section 13 or 15(d) of the 
Securities Exchange Act of 1934 [15 U.S.C. 78a et seq.] (``Exchange 
Act''). We recently approved a proposed rule amendment to Rule 6530 
of the National Association of Securities Dealers, Inc. (``NASD'') 
to limit quotations on the OTC Bulletin Board (``OTCBB'') to the 
securities of issuers that make current filings under Section 13 or 
15(d) or other applicable regulatory authority, among other matters. 
See Release No. 34-40878 (January 4, 1999) [64 FR 1255]. As such, 
once an OTCBB issuer becomes subject to our reporting requirements, 
it would be ineligible to use Rule 504.
    In our recent Securities Act Reform proposals, we solicited 
comment on whether a reporting company should be able to rely on 
Rule 504 for the issuance of securities underlying convertible 
securities and warrants that it had previously offered in compliance 
with Rule 504 when it was not a reporting company. See Release No. 
33-7606 (November 3, 1998) [63 FR 67174].
    \7\ Other issuers that are ineligible to use Rule 504 include 
investment companies or development stage companies that either have 
no specific business plan or purpose or have indicated that the 
business plan is to engage in a merger or acquisition with an 
unidentified company or companies, or other entity or person. See 
Rule 504(a) of Regulation D.
    As with all Regulation D offerings, we require a Form D, a 
simple six-page notice, to be filed with us no later than 15 days 
after the first sale in the Rule 504 offering. See Rule 503 of 
Regulation D [17 CFR 230.503]. Filing a Form D is not, however a 
condition to the exemption.
    \8\ Rule 504 offerings are aggregated for this purpose with all 
other offerings exempt under Section 3(b) (e.g., Rule 504 or Rule 
505 offerings) and all offerings made in violation of Section 5(a) 
of the Securities Act [15 U.S.C. 77e(a)].
    \9\ See interpretive letter to Mr. E.H. Hawkins (June 26, 1997), 
setting forth the views of the Division of Corporation Finance that 
affiliates who receive securities in a Rule 504 offering are subject 
to resale limitations.
    \10\ See fn. 17 and 18, below.
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    While Regulation D offerings are exempt from federal securities 
registration requirements, currently these offerings must be registered 
in each state in which they are offered unless a state exemption is 
available.\11\ The vast majority of states require registration of 
public Rule 504 offerings.\12\ In adopting Rule 504, we placed 
substantial reliance upon state securities laws because the size and 
local nature of these small offerings did not appear to warrant 
imposing extensive federal regulation. These offerings continue, 
however, to be subject to federal antifraud and other civil liability 
provisions.
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    \11\ See, e.g., the Uniform Limited Offering Exemption 
(``ULOE'') developed by the North American Securities Administrators 
Association, Inc. (``NASAA''), which was designed to be a 
coordinating state exemption with Rule 505 of Regulation D, and 
optionally Rule 506. Rule 504 is not a part of ULOE.
    NASAA is an association of securities commissioners from each of 
the 50 states, the District of Columbia, Puerto Rico, Mexico and 
several provinces of Canada.
    \12\ New York and the District of Columbia do not require 
registration of Rule 504 offerings.
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    Unfortunately, there have been recent disturbing developments in 
the secondary markets \13\ for some securities

[[Page 11091]]

initially issued under Rule 504,\14\ and to a lesser degree, in the 
initial Rule 504 issuances themselves.\15\ These offerings generally 
involved the securities of ``microcap'' companies, i.e., those 
characterized by thin capitalization, low share prices, limited public 
information and little or no analyst coverage. Recent market 
innovations and technological changes, most notably, the Internet, have 
created the possibility of nation-wide Rule 504 offerings for 
securities of non-reporting companies that were once thought to be sold 
locally.
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    \13\ These secondary markets include the OTCBB operated by the 
NASD or the pink sheets published by the National Quotation Bureau, 
Inc.
    \14\ See, e.g., SEC v. Szur, et al., Lit. No. 15595, S.D.N.Y., 
December 18, 1997; SEC v. Badger, et al. Lit. No. 15595, S.D.N.Y., 
December 18, 1997; SEC v. Scudiero, et al., Lit. No. 15595, 
S.D.N.Y., December 18, 1997; SEC v. Ruge, et al., Lit. No. 15595, 
S.D.N.Y., December 18, 1997; and SEC v. Pignatiello, et al., Lit. 
No. 15595, S.D.N.Y., December 18, 1997. In these cases, we filed 
five civil injunctive actions charging fifty-eight defendants with 
manipulation of the over-the-counter markets for ``microcap'' 
securities. The five actions were the result of an undercover 
investigation into illegal practices in these markets conducted by 
the United States Attorney's Office for the Southern District of New 
York and the Federal Bureau of Investigation, with assistance from 
the NASD and us.
    See also Schroeder, ``Penny Stock Fraud is Again on a 
Resurgence, Bolstered by Loopholes and New Technology, Wall St. J., 
September 4, 1997 at 12.
    \15\ See, e.g., SEC v. Millennium Software Solutions, Inc. and 
Mark Shkolir, Lit. No. 15603, S.D.N.Y., December 23, 1997 and SEC v. 
Spacedev, Inc. and James W. Benson, Securities Act Rel. No. 7561, 
August 6, 1998.
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    In some cases, Rule 504 has been used in fraudulent schemes to make 
prearranged ``sales'' of securities under the rule to nominees in 
states that do not have registration or prospectus delivery 
requirements. As a part of this arrangement, these securities are then 
placed with broker-dealers who use cold-calling techniques to sell the 
securities at ever-increasing prices to unknowing investors. When their 
inventory of shares is exhausted, these firms permit the artificial 
market demand created to collapse, and investors lose much, if not all, 
of their investment. This scheme is sometimes colloquially referred to 
as ``pump and dump.''
    Regulation D is only available for offers and sales by an issuer of 
securities to initial purchasers; it is not available to any affiliate 
of the issuer or to any person for resales of the securities.\16\ Thus, 
where a purchaser of Rule 504 securities wishes to sell these 
securities, he or she must either register the transaction or have an 
exemption for the transaction. Those who purchase such securities with 
a view to their distribution are acting as ``underwriters'' \17\ and 
thus their sales of the securities are not exempt from 
registration.\18\ In these circumstances, these persons could be 
charged with violating Section 5 of the Securities Act.\19\ In 
addition, they could be charged with violating the antifraud provisions 
of the Securities Act and the Exchange Act for any material 
misrepresentations made in the Rule 504 offering.\20\
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    \16\ See Preliminary Note 4 to Regulation D.
    \17\ The term ``underwriter'' is defined in Section 2(a)(11) of 
the Securities Act [15 U.S.C. 77(b)(11)] to include ``any person who 
has purchased from an issuer with a view to, or offers or sells for 
an issuer in connection with, the distribution of any security, or 
participates or has a direct or indirect participation in any such 
undertaking, or participates or has a participation in the direct or 
indirect underwriting of any such undertaking. * * *
    \18\ In particular, the ``resale'' exemption of Section 4(1) of 
the Securities Act [15 U.S.C. 77d(1)] is unavailable since the 
exemption is available to ``any person other than an issuer, 
underwriter or dealer.'' In this case, the purchasers are acting as 
underwriters, as explained above. The dealer exemption of Section 
4(3) of the Securities Act [15 U.S.C. 77d(3)] also is unavailable 
where the person relying upon the exemption acts as an 
``underwriter.''
    See also Note 6 to Regulation D, which provides that Regulation 
D is not available to any issuer for any transaction or chain of 
transactions that, although in technical compliance with the rules, 
is part of a plan or scheme to evade the registration provisions of 
the Securities Act. In such cases, registration is required.
    \19\ 15 U.S.C. 77e.
    \20\ Section 17 of the Securities Act [15 U.S.C. 77q(a)], 
Section 10(b) of the Exchange Act [15 U.S.C. 78j(b)] and Rule 10b-5 
thereunder [17 CFR 240.10b-5].
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    On May 21, 1998, we proposed amendments to Rule 504 to eliminate 
the freely tradable nature of the securities issued under the 
exemption.\21\ If we adopted that proposal, these securities could be 
resold only:
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    \21\ Release No. 33-7541 (May 21, 1998) [63 FR 29168] (``Rule 
504 Proposing Release''). The Commission received 33 letters of 
comment. The comment letters are available for inspection and 
copying in the Commission's Public Reference Room in File No. S7-14-
98. Comments that were submitted electronically are available on the 
Commission's website (www.sec.gov).
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     After the one-year holding period of Rule 144\22\;
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    \22\ 17 CFR 230.144.
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     Through registration; or
     Through another exemption (such as Regulation A\23\), if 
available.

    \23\ 17 CFR 230.251 et seq.
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By making all securities issued in a Rule 504 transaction restricted, 
we thought that unscrupulous persons would be less likely to use the 
rule as the source of freely tradable securities they need to 
facilitate their fraudulent transactions.
    In the Rule 504 Proposing Release, we also solicited comment on an 
alternative to revise Rule 504 so it would be substantially similar to 
its pre-1992 format, permitting public offerings only where the issuer 
complies with state registration processes that require the preparation 
and delivery of a disclosure document to investors before sale of the 
securities. We also solicited comment on the appropriate treatment for 
offerings made under certain state exemptions, such as the one recently 
developed for sales to accredited investors.\24\
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    \24\ State exemptions of this nature include those based upon 
the ``Model Accredited Investor Exemption,'' which was adopted by 
NASAA in 1997. CCH NASAA Reporter Para.361. Generally, the rule 
exempts offers and sales of securities from state registration 
requirements, if among other matters, the securities are sold only 
to persons who are, or are reasonably believed to be, ``accredited 
investors'' as defined in Rule 501(a) of Regulation D [17 CFR 
230.501(a)]. The model restricts transfer of the securities for 12 
months after issuance except to other accredited investors or if 
registered. Written solicitations under that provision are generally 
limited to a type of ``tombstone'' ad.
    As of December 31, 1998, 29 states and the Commonwealth of 
Puerto Rico have an accredited investor exemption permitting some 
form of general solicitation and two states had adopted specific 
accredited investor exemptions to work with the U.S. Small Business 
Administration's Angel Capital Electronic Network (ACE-Net). Of 
these, 15 states have adopted NASAA's Model Accredited Investor 
Exemption through statute, regulation or executive order. The 
remaining 14 states either have accredited investor exemptions pre-
dating the Model Exemption or have adopted variations of the Model 
Exemption. Of the 19 states that do not have an accredited investor 
exemption permitting general solicitation, seven have statutory or 
regulatory language pending to adopt such an exemption.
    ACE-Net is an Internet-based, securities listing service where 
small, growing companies can list their stock offerings to 
accredited investors. It is a public/private partnership between the 
SBA and 38 non-profit, university-and state-based entities around 
the country. See Angel Capital Electronic Network (pub. avail. 
October 25, 1996).
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    For the reasons discussed below, we are again conditioning the 
availability of Rule 504 for public offerings on the extent of state 
regulation over those offerings by making the exemption substantially 
similar to its pre-1992 format.\25\ We believe that this alternative is 
an effective way to combat the abuses we have described and at the same 
time preserve the ability of legitimate small businesses to raise 
capital. This approach is more narrowly targeted to the abuses we have 
observed than simply restricting all securities issued in a Rule 504 
transaction. As amended, the rule establishes the general principle 
that securities issued under the exemption, just like the other 
Regulation D exemptions, will be restricted, and prohibits general 
solicitation and general advertising, unless the specified conditions

[[Page 11092]]

permitting a public offering are met. These conditions are:
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    \25\ Unlike the rule as amended today, the pre-1992 format of 
Rule 504 did not include a provision for state law exemptions for 
sales made to accredited investors or any requirement for publicly 
filing the disclosure document that is delivered to investors 
although this has long been a standard feature of state registration 
provisions. It also required issuers in private Rule 504 offerings 
to advise purchasers of the resale limitations on the securities a 
reasonable period of time before sale.
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     The transactions are registered under a state law 
requiring public filing and delivery of a disclosure document before 
sale. For sales to occur in a state without this sort of provision, the 
transactions must be registered in another state with such a provision 
and the disclosure document filed in that state must be delivered to 
all purchasers before sale in both states; or
     The securities are issued under a state law exemption that 
permits general solicitation and general advertising so long as sales 
are made only to ``accredited investors'' as that term is defined in 
Regulation D.\26\

    \26\ See Rule 501(a) of Regulation D.
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Investor protection concerns require that this action be taken to curb 
misuse of this exemption in the markets for ``microcap'' companies. 
Requiring issuers to go through state registration and deliver 
disclosure documents to investors in order to issue freely tradable 
securities in Rule 504 transactions provides information for 
prospective investors to make more informed investment decisions. These 
amendments are part of our comprehensive agenda to deter registration 
and trading abuses, particularly by ``microcap'' issuers. We have 
developed a four-pronged approach to deter ``microcap'' fraud: 
enforcement, investor education, compliance examinations, and 
regulation.\27\
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    \27\ We are issuing four companion releases today. See Release 
No. 33-7646, which adopts revisions to Form S-8, the short-form 
registration statement for issuing securities to employees, 
consultants and advisors as compensation, in order to curb abusive 
situations and Release No. 33-7647, which contains additional 
proposals to Form S-8 to further reduce abuse of the form. See 
Release No. 34-41110, which reproposes amendments to Exchange Act 
Rule 15c2-11 [17 CFR 240.15c2-11] to require the first broker-dealer 
that publishes any quotation for a covered security to review 
information about the issuer and thereafter other broker-dealers to 
review information about the issuer when they first publish or 
resume publishing a priced quotation for a covered security. See 
also Release No. 33-7645, which adopts amendments to Form 701, the 
exemption for non-reporting companies to issue securities to 
employees, consultants and advisors.
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    We believe the amendments to Rule 504 adopted today will deter the 
abuses we have seen, while not impeding legitimate ``seed capital'' 
offerings. We will monitor the use of the rule, as revised, and also 
contact the state regulatory authorities regarding their experience 
with these offerings. If it appears that Rule 504 is still being 
misused, we will consider adding stronger measures, such as requiring 
an after-market information delivery requirement \28\ or 
disqualification provisions.\29\ With respect to the accredited 
investor aspect of the revised rule, we will work with the states to 
assess its use. If the new regulatory scheme is being misused, 
particularly in states that do not impose transfer restrictions on the 
resale of the securities by accredited investors, we will explore with 
these states the viability of imposing such restrictions under their 
provisions. Failing that, we would consider making the securities 
``restricted'' as defined in Rule 144.
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    \28\ See Section 4(3) of the Securities Act [15 U.S.C. 77d(3)], 
Securities Act Rule 174 [17 CFR 230.174] and Rule 251(d)(2)(ii) of 
Regulation A [17 CFR 230.251(d)(2)(ii)].
    \29\ See Rule 505(b)(2)(iii) of Regulation D [17 CFR 
230.505(b)(2)(iii)] or Rule 262 of Regulation A [17 CFR 230.262].
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II. Amendments to Rule 504

    Before 1992, Rule 504 exempted both public and private offerings. 
It exempted public offerings if sales did not exceed $1 million \30\ in 
a 12-month period and if the offering was registered with one or more 
states that required the preparation and delivery of a disclosure 
document to investors before sale.\31\ Private offerings, in which 
general solicitation and general advertising were prohibited, were 
exempt if sales did not exceed $500,000. State registration was not a 
condition to the exemption in the private context.
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    \30\ As originally adopted in 1982, the exemption was subject to 
a $500,000 limitation. In 1988, the ceiling for public offerings was 
increased to $1 million. See Release No. 33-6758 (March 3, 1988) [53 
FR 7866].
    \31\ For example, Form U-7 (also referred to as ULOR, uniform 
limited offering registration, or SCOR, small corporate offering 
registration) was developed by NASAA to be a special registration 
format for companies registering securities under state securities 
laws when relying upon the federal Rule 504 exemption. See Harris, 
Keller, Stakias & Liles, Financing the ``American Dream.''
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    In July 1992, we adopted revisions to our rules and forms to 
facilitate capital raising by small businesses by reducing the 
compliance burdens placed on those companies by the federal securities 
laws.\32\ The amendments eliminated all restrictions on the manner of 
offering and on resales under Rule 504. As a result, a non-reporting 
company could offer up to $1 million of securities in a 12-month period 
and be subject only to the antifraud provisions of the federal 
securities laws. General solicitation and general advertising were 
permitted for all Rule 504 offerings. Further, securities sold under 
Rule 504 were not ``restricted'' securities and thus were available for 
immediate resale by non-affiliates of the issuer, as long as they were 
not otherwise ``underwriters'' \33\ of the offering.\34\
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    \32\ See Release No. 33-6949 (July 30, 1992) [57 FR 36442]. On 
April 28, l993, we adopted additional revisions to further 
facilitate financings by small business issuers. See Release No. 33-
6996 (April 28, 1993) [58 FR 26509].
    \33\ Section 2(a)(11) of the Securities Act [15 U.S.C. 
77b(a)(11)].
    \34\ Regulation D exemptions are available only to the issuer of 
the securities. None of these exemptions can be used by any other 
person. See Preliminary Note 4 to Regulation D.
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    In the Rule 504 Proposing Release, we proposed that all securities 
issued in a Rule 504 transaction would be ``restricted'' from resale 
for a one-year period after issuance. This proposal directly addressed 
the abuses we witnessed in the secondary markets. Almost all commenters 
objected to this approach, since it would require issuers to offer a 
significant liquidity discount in all Rule 504 issuances, even fully 
state registered ones, causing a significant reduction in the amounts 
of capital they could raise. While acknowledging that this approach 
would have some impact upon the targeted problem in the secondary 
market, commenters, including NASAA, believed that our alternative 
approach, which was to reinstitute the rule largely as it had been in 
effect for a number of years before 1992, would be equally, if not 
more, effective since if an issuer goes through state registration and 
must deliver a disclosure document to prospective investors, sufficient 
information ought to be available in the markets to permit investors to 
make more informed investment decisions and thus deter manipulation of 
Rule 504 securities. They also noted that this approach would not 
unduly penalize small businesses, since they would have some avenue 
open to them to issue freely transferable securities.
    The amendments we adopt today implement the alternative narrower 
reform. By returning the Rule 504 exemption largely to its pre-1992 
framework, we intend to deter ``microcap'' fraud. We believe that the 
vast majority of current Rule 504 offerings are private. Private 
offerings under Rule 504 will be permitted for up to $1 million in a 
12-month period, under the same terms and conditions, except for the 
specific disclosure requirements,\35\ as offerings under Rules 505 and 
506. Securities in these offerings will be restricted, and these 
offerings may no longer involve general solicitation and advertising.
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    \35\ Rule 502(b)(1) of Regulation D [17 CFR 230.501(b)(1)].
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    On the other hand, the rule as revised leaves avenues open for 
issuers to make less limited offerings under Rule 504. By focusing on 
state registration, review and disclosure requirements, we are still

[[Page 11093]]

permitting legitimate small issuers to access the capital markets 
without having to sell restricted securities. In adopting this reform, 
we note that the state registration and review system is generally 
comprehensive. As of the effective date of these amendments, an issuer 
will only be able to issue unrestricted or freely tradable securities 
in a Rule 504 offering and engage in general solicitation or general 
advertising in two circumstances:
     If it registers the offering under a state law that 
requires the public filing \36\ and delivery of a disclosure document 
to investors before sale; \37\ or
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    \36\ The disclosure document must be publicly available at the 
state level. This document must provide substantive disclosure to 
investors, including the business and financial condition of the 
issuer (including financial statements), the risks of the offering, 
a description of the securities, and the plan of distribution. For 
example, the issuer could provide the information required in a Form 
U-7, as outlined in n.37, to satisfy this requirement.
    \37\ If any state that the issuer intends to make sales in does 
not provide for the registration or the public filing or delivery of 
a disclosure document to investors before sale, then in order to be 
able to issue freely tradable securities and to engage in public 
solicitation or public advertising, the issuer must register in at 
least one state with such a procedure. The disclosure document must 
be delivered before sale to all purchasers, including purchasers in 
the states that have no registration and delivery procedure. The 
process does not allow using one state's prospectus in another state 
where the second state provides a conforming procedure.
    In states that have adopted the Small Corporate Offering 
Registration (``SCOR'') Review Statement of Policy, information on 
an issuer is available to investors through Form U-7. The Form U-7 
contains a series of 50 very detailed questions on the issuer's 
business, intended use of proceeds, management, principal 
stockholders, and plan of distribution. In addition, the issuer must 
file historical financial statements prepared in accordance with 
generally accepted accounting principles in the United States. Form 
U-7 has been either formally adopted or recognized and accepted by 
45 states.
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     If the transaction is effected under a state law exemption 
that permits general solicitation and general advertising so long as 
sales are made only to ``accredited investors.'' \38\
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    \38\ Generally, these securities may not be freely transferred 
under state law. The Model Accredited Investor Exemption provides 
that any resale of a security sold in reliance of the exemption 
within 12 months of sale will be presumed to be with a view to 
distribution and not for investment, a requirement of the exemption, 
except for limited circumstances. With respect to general 
solicitation and advertising, the Model Accredited Investor 
Exemption specifies that only a tombstone ad may be used; however, a 
few states have no restriction on general solicitation and 
advertising so long as sales are only made to accredited investors.
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    These amendments will be effective April 7, 1999. Rule 504 
offerings that begin on or after this date will have to comply with the 
new rule. With respect to Rule 504 offerings that are ongoing at the 
time of the amendments, issuers will have to discontinue offers and 
register under a state law requiring the preparation and delivery of a 
disclosure document to investors before sale in order to issue freely 
tradable securities.
    The pre-1992 approach strikes an appropriate balance between the 
needs of legitimate small businesses to issue freely tradable 
securities to obtain seed capital, while still protecting 
investors.\39\ The amendments will preserve an avenue for small 
businesses to issue freely tradable securities and not suffer deep 
liquidity discounts, while at the same time they will protect investors 
by curbing the use of Rule 504 securities in connection with fraudulent 
transactions.
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    \39\ We have an ongoing dialogue with small business and their 
representatives. Since September 1996, we have hosted 12 SEC Small 
Business Town Hall Meetings across the country to discuss issues 
like our capital formation rules. We learn about the current 
concerns and problems of small businesses in raising capital in the 
securities markets so that we can implement programs to meet their 
needs consistent with the protection of investors. Three meetings 
have been held since the proposals were issued. At each meeting, we 
discussed the Rule 504 Proposing Release and encouraged attendees to 
submit their views as part of the rulemaking process.
    In addition, every year we host the Government-Business Forum on 
Small Business Capital Formation. In September 1998, we held the 
Seventeenth Annual Forum in Chicago. The Rule 504 Proposing Release 
generated significant discussion there as well.
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III. Cost-Benefit Analysis

    In the Rule 504 Proposing Release we asked the public for their 
views on the costs and benefits of the proposal and other supporting 
information. No commenter provided data on the plan we adopt today.
    We believe that those who will rely on the rule will not have 
significantly increased costs. In fact, since the rule is essentially 
being maintained as it has always operated, given the necessity of 
state law compliance, the vast majority of issuers should have no 
additional costs of compliance. The main impact will be that issuers 
who make offerings in states that do not provide for the registration 
provision dictated by the rule will have to register in another state 
in order to have a public offering and issue that state's residents 
freely tradable securities. We understand that issuers who intend to 
issue securities in New York and the District of Columbia are the only 
ones that will be affected by this change. We understand that the 
average cost of preparing and filing a Form U-7 filing is $30,000.\40\ 
It is because of the mandate of investor protection that we are making 
this change. Overall, the rule will maintain the benefits that allow 
small companies to raise ``seed capital'' with a minimal federal 
compliance scheme for public offerings. Private offerings also are 
being affected since they will no longer be able to use general 
solicitation or advertising and securities issued in these offerings 
will be restricted. The Commission has concluded that the amendments 
will not result in significant adverse effects on efficiency, 
competition, or capital formation.
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    \40\ This estimate is from a 1997 survey conducted by the SCOR 
Report, a newsletter that covers all aspects of small business 
finance.
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IV. Summary of the Final Regulatory Flexibility Analysis

    In accordance with 5 U.S.C. Sec. 604, we have prepared a final 
Regulatory Flexibility Analysis (``FRFA'') regarding the amendments.
    The analysis notes that the amendments to Rule 504 are a result of 
our view that the current configuration of the exemption may be leading 
to abuse, as well as concerns expressed to us by representatives of 
other regulators. The purpose of the revisions is to reduce the 
potential for abuse and yet maintain the utility of the exemption for 
small businesses. We have determined that the amendments will enhance 
the protection of the investing public.
    As the FRFA describes, in calendar year 1998, 2,988 Forms D were 
filed by 2,499 companies with the Commission claiming the Rule 504 
exemption. Rule 504 only affects non-reporting companies. The 
Commission has sought to minimize the reporting burden on small 
businesses. However, we do not collect data to determine how many of 
the non-reporting companies filing Form D are small businesses. The 
amendments will only affect issuers offering and selling in certain 
jurisdictions. We do not know the number of Rule 504 offerings in these 
jurisdictions. Therefore, we are unable to determine exactly how many 
small businesses will be affected by the proposed amendments.
    While it is not possible to know with certainty, it is believed 
that most of these offerings were done by small businesses. Small 
businesses affected by the changed rule include those that make a 
``public'' offering of securities in one of the jurisdictions that does 
not require prospectus delivery before sale. The rule changes would 
require the securities to be registered in a state that requires 
prospectus delivery before sale or that exempts general solicitations 
of accredited investors. In the alternative, these companies could use 
the rule to make a private offering, which could involve their offering 
a liquidity discount for their shares and thus increase their cost for 
capital. The Commission has insufficient data to

[[Page 11094]]

reliably quantify the impact on small entities offering such a 
discount.
    The amendments do not impose any new recordkeeping requirements or 
require reporting of additional information. The amendments require 
issuers in certain jurisdictions to register in states they might not 
otherwise register. We understand that the average cost of a Form U-7 
filing is $30,000.\41\
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    \41\ See fn. 40, above.
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    As discussed more fully in the FRFA, several possible significant 
alternatives to the proposals were considered. These included 
establishing different compliance or reporting requirements for small 
entities, exempting them from all or part of the proposed requirements, 
or requiring them to provide more disclosure, such as the same 
disclosure as required for the other Regulation D exemptions. We also 
considered restricting the resale of these securities. We concluded 
that the costs of this proprosal exceeded the benefit. The FRFA also 
indicates that there are no current federal rules that duplicate, 
overlap, or conflict with the proposed rule amendments.
    We encouraged written comments on any aspect of the initial 
regulatory flexibility analysis (IRFA), but received no specific 
comments in response to our request. In particular, we sought comment 
on: (1) the number of small entities that would be affected by the 
proposed rule amendments; and (2) the determination that the proposed 
rule amendments would not increase the reporting, recordkeeping and 
other compliance requirements for small entities. A copy of the FRFA 
may be obtained from Twanna M. Young, Office of Small Business, 
Division of Corporation Finance, Securities and Exchange Commission, 
450 Fifth Street, NW, Washington, DC 20549.

V. Paperwork Reduction Act

    We submitted the initial proposal for review in accordance with the 
Paperwork Reduction Act of 1995 (``the Act'').\42\ The title to the 
affected information collection is: ``Form D.'' The specific 
information that must be included in Form D is explained in the form 
itself, and relates to the issuer, its principals and the amount of 
money proposed to be raised along with proposed applications of the 
proceeds. The information is needed for monitoring use of the exemption 
as well as evaluating its usefulness. The effect of the rule amendment 
is to require some issuers to prepare registration and disclosure 
documents they currently are not required to file.
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    \42\ 44 U.S.C. 3501 et seq.
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    The collection of information in Form D will continue to be 
required in order for companies to use the rule for sales of their 
securities. While we cannot estimate the number of respondents that may 
use revised Rule 504, in calendar year 1998, there were 2,988 Forms D 
filed by 2,499 companies with the Commission claiming the Rule 504 
exemption. We believe that the vast majority of these were private Rule 
504 offerings. We expect that approximately 2,250 companies each year 
will be relying on the exemption. With the revisions to Rule 504 the 
estimated burden for responding to the collection of information in 
Form D would not increase for most companies because the information 
required has not been changed. The number of eligible transactions, 
however, may decrease. We do not know how many issuers currently offer 
or sell securities pursuant to Rule 504 in states without a requirement 
to deliver a disclosure document to investors before sale. We estimate 
that the burden hours per respondent each year will be unchanged at 16. 
Therefore, we estimate an aggregate of 36,000 burden hours per year.
    The information collection requirements imposed by Form D are 
mandatory to the extent that a company elects to use the Rule 504 
exemption. The information will be disclosed to third parties or the 
public. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number. The OMB control number is 3235-0076.
    We received no comments in response to our solicitation of comments 
regarding the information collection obligation.

VI. Statutory Basic, Text of Amendments and Authority

    The amendments are made pursuant to Sections 2, 3(b), 6, 7, 8, 10, 
19(a), 19(c) and 28 of the Securities Act.

List of Subjects in 17 CFR Part 230

    Reporting and recordkeeping requirements, Securities.

    For the reasons set out in the preamble, title 17, chapter II of 
the Code of Federal Regulations is amended as follows:

PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933

    1. The authority citation for part 230 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77r, 77s, 77sss, 
78c, 78d, 78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 80a-24, 80a-
28, 80a-29, 80a-30, and 80a-37, unless otherwise noted.
* * * * *
    2. By revising Sec. 230.504(b)(1) to read as follows:


Sec. 230.504  Exemption for limited offerings and sales of securities 
not exceeding $1,000,000.

* * * * *
    (b) Conditions to be met. (1) General conditions. To qualify for 
exemption under this Sec. 230.504, offers and sales must satisfy the 
terms and conditions of Secs. 230.501 and 230.502 (a), (c) and (d), 
except that the provisions of Sec. 230.502 (c) and (d) will not apply 
to offers and sales of securities under this Sec. 230.504 that are 
made:
    (i) Exclusively in one or more states that provide for the 
registration of the securities, and require the public filing and 
delivery to investors of a substantive disclosure document before sale, 
and are made in accordance with those state provisions;
    (ii) In one or more states that have no provision for the 
registration of the securities or the public filing or delivery of a 
disclosure document before sale, if the securities have been registered 
in at least one state that provides for such registration, public 
filing and delivery before sale, offers and sales are made in that 
state in accordance with such provisions, and the disclosure document 
is delivered before sale to all purchasers (including those in the 
states that have no such procedure); or
    (iii) Exclusively according to state law exemptions from 
registration that permit general solicitation and general advertising 
so long as sales are made only to ``accredited investors'' as defined 
in Sec. 230.501(a).
* * * * *
    Dated: February 25, 1999.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-5295 Filed 3-5-99; 8:45 am]
BILLING CODE 8010-01-U