Hey, Tilden Moschetti, syndication attorney with the Moschetti Syndication Law Group. I put together private placement memorandums under Regulation D Rule 506b and Rule 506c for syndicators, businesses trying to raise capital, crypto miners, or really anybody who’s trying to raise money that actually is a security. That’s me, I’m the guy to help you. Today I want to do a deep dive into a question that I get quite a bit when people see private placement memorandums from me. And that is a section on the limitations on resale. It sounds scary, and in some respects, it might be scary. But let’s go take a deep dive and see exactly what we’re talking about.
Tilden Moschetti, syndication attorney with the Moschetti Law Group doing private placement memorandums for syndicators just like you. Today, we’re going to take a deep dive into limitations on resale. And just like in some of our other videos, we’re going to actually look at the code section. But before we do that, I want to talk in general about why there are limitations on resale and what the SEC is thinking.
In general, an offering is required to be registered with the SEC. Now there are some exemptions to registration under the Securities Act, one of those is Regulation D. Under Regulation D, private offerings do not need to be registered. Yes, you do need to file a Form D. But that’s all it really needs from the SEC’s point of view – that you’ve done all the things that are required of it, and that you file a Form D. It does not need a formal registration.
In order to do this, the SEC has made some Rules to limit exactly how this takes place. Some of those are described in great detail in Rules 506b and 506c about what’s allowed and what’s not, who’s allowed to invest and who’s not, or how to do certain things. One of these things is it is necessary under the Rules to inform your investors that there are limitations placed on resale. Because what the SEC doesn’t want is for syndicators to basically put this all together, put it out into the marketplace and have a secondary market get born up out of this whole money pool that’s outside of their regulation. So that created this limitation on resale to try and stem that secondary marketplace from arising.
So to do that, let’s look at what the Rule is. Let’s go to the whiteboard. There it is. And we’re talking about Rule 502(d), which talks about the limitations on resale.
[The speaker then reads the Rule 502(d) from the whiteboard]
Now, this says “except as provided in Rule 230.504(b)(1)”. Do not be confused. This is 504, not 506b. 504b is very different from 506b. Actually, 504b isn’t used that commonly in my experience. It is certainly there and it can be used, but oftentimes it is a little bit more complicated to put together. And so most indicators use 506b or 506c.
With that digression aside, let’s talk again about limitations on resale. So any security that’s “acquired in a transaction under Regulation D shall have the status of securities acquired in that transaction under section 4(a)(2) of the Act” – by the Act, we’re talking about the Securities Act of 1933 – “And it cannot be sold without registration under the act.” So registration, that’s what we’re trying to avoid in a private offering, or an exemption therefrom, so Regulation D for example.
The issuer shall exercise reasonable care to assure that purchasers of the securities are not underwriters, so they’re not people who just go out and are publicly packaging up these bundles of securities in order to take them to that secondary marketplace. And reasonable care may be demonstrated by the following. So they give us some examples on how exactly you can demonstrate that reasonable care.
First off, and I’m going to tell you in what documents we do all three of these, because there are three examples right there, so we’re going to tell you where we do them all for you.
Number one is a reasonable inquiry to determine if the purchaser is acquiring the securities for himself or for other persons. This is one of the reasons that I believe that every package that contains a PPM and operating agreement and a subscription agreement should also include an investor questionnaire. One of the questions in our investment questionnaire that we prepare for clients is this question: “Who are you buying these securities for?” That establishes Rule number one, this demonstrated act number one, you’re making that inquiry.
Now, oftentimes, that inquiry also takes place in the negotiation of what exactly it is, or in the sales process of that security, where you’re talking to a potential investor, and you’re saying, “Are you going to be buying this for yourself or for another person?” That happens quite a bit. But another place that we actually document that happening is in that investor questionnaire.
Number two is a written disclosure to each purchaser prior to the sale, that the securities have not been registered under the Act, and therefore cannot be resold unless they are registered under the Act or unless an exemption from registration is available. So in our PPM itself, the very first page that we put up there, it says that these securities have not been registered under the Act and therefore cannot be resold unless they are registered under the Act or unless an exemption for registration is available. So we’re making that written disclosure on page one, we’re also making it in various other sections where it would be applicable or may, we want to call it out, to make it very clear to investors that you can’t just buy these for the purpose of resale.
So therefore, we have met number one and number two on those. So here is the PPM. And number one, again, was the investor questionnaire.
Number three, placement of a legend on the certificate or another document that evidences the securities stating that the securities have not been registered under the Act and setting forth or referring to the restrictions on transferability and sale of the securities. So again, most syndicators do not issue membership certificates. But if they choose to, that should be on the certificate. Where we put this, when we put together the packages that we put together, is we put this in the subscription agreement. The subscription agreement is that agreement between the syndicator and the investor themselves, that states amongst other things that they know, and they’ve been informed that the securities have not been registered under the Act, and that they should refer to the restrictions and transferability of the sale of securities, and that they will abide by those Rules.
So we cover it in all three of the suggested ways where reasonable care may be demonstrated. So again, this is the Rule on limitations on resale.
So what exactly do we mean by limitations? When we’re saying limitations, we don’t mean that you can’t completely resell these. What we’re saying is, or the SEC, what it is saying is that you can’t have an investor go and purchase these securities merely contemplating that the security itself will rise and then they will resell it. The purpose of these is not for resale of the security itself. It’s for the profits that will be gained within the security. So that security is paying out cash dividends sometimes or it’s paying out a reversion or it’s paying out something in order to give the investor value. But its purpose is not like you think of the stock market where Apple shares are selling at this, and we’re hoping it goes up by 5%, at which point I’m going to sell it. That’s not the point.
So the other limitations are, and how we address that is, if you can’t just create a marketplace to sell this, what can you do? Say one of your investors gets into a situation where they really need the cash that they’ve contributed to your investment and you’d like to help them out. Well, typically, what we do is we create a right of first refusal. So right of first refusal gives you the manager or your members, or both of you, or gives somebody the right to buy those securities from that initial member and put them in your own account.
Now you guys can negotiate price of what that should be, what a fair price would be. But we’d like to give you guys the initial shot. I want the manager to get it because you are the manager in this case. And I want you to have the ability to increase your own stake if you want it. Second, it’s great to have the members also have a bite at the apple too, because those are members that you already like and are already part of your investment. And they’re obviously happy if they’re interested in buying more shares. And so you already know them, it’s already established.
Now should those fail, then they can go and sell their securities to other people as well. They just need to come to you first typically. And they can find people as long as that whole purpose wasn’t to just resell them. Or they can transfer them to their family or children. That’s very common for something like that to happen. But the purpose was not in that resale capacity.
So I hope that explains those limitations on resale. So there are limitations. They’re not “you can’t ever do this.” But it is also very specific that don’t go and try and create a market and we make it very clear for the investors that they can’t just go and do that so that you’re complying under Rule 502(d).
So again, my name is Tilden Moschetti. I am a securities attorney. I specialize in Regulation D offerings. We focus exclusively on syndication and I write private placement memorandums, operating agreements, subscription agreements, investor questionnaires for syndicators, businesses, anyone trying to raise capital and that raising of capital amounts to a security. Those are who I help exclusively under Regulation D. That’s my focus. That’s all we do. Now, if you’re interested in getting our help, we’d be happy to talk with you.