The Commission determined in 1989 to eliminate the requirement that a Form D had to be filed in an offering under Regulation D as a condition of the exemption. The decision was tempered by the decision to simultaneously adopt Rule 507 of Regulation D and providing the Commission with the authority to bar issuers that did not file the Form from using the exemption. The failure of the Commission to use the Rule, however, has demonstrated that this was an insufficient mechanism for ensuring compliance. Moreover, the analysis by DERA suggests that noncompliance with the filing requirement is rampant.
Recognizing this, the proposed reforms of Regulation D currently under consideration include a solution of sorts. Issuers that did not meet the requirements of Rule 503 (filing a Form D and filing appropriate amendments) would be barred for a five year period from using Rule 506. Once they came into compliance, they would be barred from using the Rule for a one year period.
The proposal is an admission that the Rule 507 approach has not worked. Nonetheless, there is every reason to believe that the one year "time out" will have little or no effect on the problem of noncompliance. First, the effectiveness of the penalty is impaired by the problems of detection. The unavailability of Rule 506 depends upon the existence of an earlier offering and noncompliance with the Form D filing requirements. The Proposal does not explain how investors and the Commission will become aware of the earlier offering, particularly given the failure to file the Form D. Thus, as a practical matter, issuers ineligible to use Rule 506 will nonetheless continue to rely on the exemption, with investors and the Commission unaware of its inapplicability.
Second, the “time out” applies to subsequent offerings. As a result, the penalty does not prevent the current offering from going forward. For issuers unconcerned about the next offering (particularly those engaging in fraudulent practices such as pump and dumps), the prospective nature of the penalty will provide little incentive to file the Form D. Moreover, it only applies if the “next offering” is within five years. Issuers often will have no expectation of using the exemption within that period.
Third, the time out only applies to Rule 506. Section 4(a)(2) would, for example, continue to be available, as would Regulation A, Rules 505 and 504, and intrastate exemption under Rule 147. As a result, issuers confronting the penalty have numerous other avenues available for selling shares in an exempt offering.
Finally, the approach presupposes that issuers are sufficiently motivated to file the Form D by the prospect of a one year delay. In a proposal that is otherwise filled with empirical observations, this assertion is curiously unsupported. Issuers will only be sufficiently motivated if they reasonably expect to conduct another offering within the five year period of the penalty. The data from DERA suggests that this is often not the case.
The most effective solution would be to reinstate the requirement that conditioned the use of Regulation D upon the filing of the Form. As a result, the Commission should simply eliminate Rule 507 and again require the filing of the Form D as a condition of the exemption. In declining to propose this reform, the Release cited concerns with“disproportionate” consequences. Specifically, the Release noted that the approach could result in uncertainty about the applicability of the exemption “until after the offering was terminated and all filings required under Rule 503 were made.”
The analysis, however, focused on the uncertainty that arose from a loss of the exemption arising from the failure to file a timely amendment to the Form D. To the extent that the exemption was conditioned only upon the timely filing of the initial Form D, there would be no uncertainty. For other requirements in Rule 503, such as the need for amendments, the Commission could apply a less severe penalty such as the proposed one year time out. Finally, to mitigate any concerns over the possible hardship resulting from the loss of an exemption due to the failure to file a Form D, the Commission could provide for waiver under the appropriate circumstances.
For more commentary on the rule proposal, see Data Collection, the SEC, and Regulation D: A Comment on Securities Act Release No. 9416 (July 10, 2013).