Federal and State Notice Filing Requirements
NOTE: This article specifically pertains federal and state-required filings for exempt securities offerings under Regulation D, Rule 506. This information is not applicable securities offerings under federal Regulation D, Rules 504 or 505, or federally exempt offering under Rule 147 (Intrastate Offerings). Further, this information is of a general, educational nature and may not be construed as legal advice pertaining to your specific offering or situation. Any such advice must be sought from your own attorney pursuant to an attorney-client relationship related to your specific questions or matters.
QUESTION: What notices must be filed with securities agencies for an exempt Real Estate Syndication under Regulation D, Rule 506?
Federal Securities Notices
When an offer and sale of securities complies with the specific requirements for an exemption from registration under Regulation D, Rules 504, 505, or 506 promulgated by the federal Securities and Exchange Commission (SEC) under the Securities Act of 1933, a “safe harbor” exemption is granted to “Issuers” of securities from both:
- Registration requirements under the Securities Act of 1933, and
- Licensing requirements for securities brokers and dealers under the Securities and Exchange Act of 1934.
The “Issuers” of such securities are generally those persons who are promoting the offering and soliciting investors. Private real estate securities offerings may be structured in the form of a Corporation, a Manager-managed limited liability company (LLC), or a Limited Partnership (LP), or a business trust, or even via use of Promissory Notes, although other structures exist.
Federal Filing Requirements — Form D
What Constitutes a Sale? One of the requirements most often overlooked by Issuers who would otherwise be entitled to an exemption from registration of their securities is the requirement that a “Form D” must be filed with the SEC within fifteen (15) days of a “sale” of a federally exempt security. For this purpose, the SEC defines “the date of first sale is the date on which the first investor is irrevocably contractually committed to invest”. For different offerings, this date could be interpreted differently. In the case of a real estate securities offering, it could be variously defined in the offering documents as the date the investor’s subscription is received, the date “impounds are broken,” or the date the investor’s money is used to acquire the real estate, or some other event or timeframe specified in the offering documents, but it most certainly occurs when an investor can no longer get their money back because it has been spent to further the objectives of a real property or business.
What is the Purpose of the Filing? The purpose of the Form D is to notify the SEC that securities are being sold to U.S. Investors and giving them information and jurisdiction over the Issuer in the event they wish to conduct an audit or receive a complaint regarding potential securities violations. If the Form D doesn’t get filed within the specified time, the Issuer exemption may not apply to the offering and the Issuer may be found to have engaged in the unlicensed sale of securities and/or selling unregistered securities, either of which could subject the Issuer to criminal or civil prosecution, fines or a forced rescission in which the Issuer must refund everyone’s money within a specified timeframe.
Who Does The Filing, The Issuer or its Attorney? If you hire an attorney to draft your Syndication offering documents, they will likely do this filing for you. However, there are many non-attorneys who draft their own securities documents and fail to comply with this required step, and there are many attorneys who will draft the offering documents, but leave it to the Issuer to file their own notices.
If the Form D isn’t timely filed, the safe harbor does not exist and the investment is at risk. The SEC could file an injunction freezing all of the assets of the company and the Issuer. Defending a charge of the unlicensed sale of securities or selling unregistered securities will likely consume all of the assets of the company and could result in a total loss of the investment for all of its investors.
Many attorneys will simply file your Form D at the time the offering commences (i.e., when they issue your final offering documents) in order to be sure you obtain the safe harbor. That way, if you forget to inform your Attorney at the time of “sale” (as defined above), you will still be entitled to the “safe harbor” at the federal level.
State Securities Notices Are Required, Too
In addition to federal notice filing requirements, even for a federally exempt offering, the offering and sale of securities are governed at the state level by each individual state’s securities agency. Just like the Form D required by the SEC, the purpose of the state securities notice is to notify the state securities agency that a security has been sold to one or more investors within their jurisdiction and giving them information and jurisdiction over the Issuer (i.e., the right to serve the out-of-state Issuer with a lawsuit) in case a securities violation is found to occur.
If the notice doesn’t get filed within the specified time, the state’s Issuer exemption does not apply to the offering and the Issuer may be found to have engaged in the unlicensed sale of securities as well as selling unregistered securities at the state level, and could be prosecuted by the state’s Attorney General or in its state courts for violating its state laws.
State Notice Filings for Regulation D, Rule 506 Offerings. One of the primary benefits of a federally exempt Regulation D, Rule 506 securities offering is that it generally pre-empts additional state requirements regarding such things as additional investor financial qualifications, limits on investment amounts, or agency pre-approval of a securities offering. Most state securities agencies simply require that the Issuer send them a copy of their Form D, along with payment of a required filing fee. State securities notice filing fees typically range from $0 to $600 each; however, only one notice must be filed in a state regardless of the number of investors from that state. The form must generally be filed within fifteen (15) days of the sale of the first security to one of their state residents.
When Must the State Notices Be Filed?
Nearly all states require the Issuer of a federally exempt securities offering to file a notice with them within 15 days of when the first security has been sold to an investor within their jurisdiction.
Many Issuers pay Attorneys considerable fees to have their offering documents professionally drafted and then blow their exemption by failing to notify their Attorneys when they make a “sale” to an investor from a new state so the state notices can be timely filed!!!
Other Federally Exempt Offerings. Offerings qualifying for an exemption under Regulation D, Rules 147, 504 and 505 may require much more extensive filings with the state, ranging from a pre-review process to sending a copy of the offering documents, and/or filing additional state forms. Rule 147 applies when the investment opportunity, the Issuer, and all of the investors are from the same state and gives the state sole jurisdiction over the offering (called an “Intrastate Offering”). A securities attorney licensed within the Issuer’s state should be consulted for intrastate Offerings.
Consequences for Failure to Timely File
Most states won’t allow late filings of Securities Noties. If an Issuer fails to file the state notice within the required timeframe, there may not be an opportunity to fix it later.
As of 2022, state regulators are starting to crack down on late filings. One of our clients got a late notice from Kentucky threatening to impose a $20,000 fine and another got a late notice from Nebraska that required filing an explanation and an affidavit, which could have cost the client a fine and additional legal fees.
The offering will be at risk for its entire duration. If something goes wrong and an investor complains or if the state learns of the sale of securities within their jurisdiction without the required notice filing, they could elect to prosecute the Issuer at any time. It is a matter of public policy that securities violations are not something for which a company can indemnify the Issuer. Thus, the defense of a securities violation will be borne solely by the Issuer. Once the door is opened for the state or federal government (or a private civil attorney representing a disgruntled investor) to scrutinize the offering, it is possible that other violations could be found, subjecting the Issuer to further liability and putting the entire investment at risk.
Further, if you have failed to comply with the rules of the exemption for a federal offering (e.g., you didn’t file the Form D, or you otherwise violated the rules for your federal exemption), you will likely be in violation of the state’s exemption from registration of your offering at the state level.
How Failures Occur and How You Can Avoid Them
Issuers need to understand that compliance with the filing requirements and deadlines are their responsibility. While an Attorney can draft the documents, help structure the offering, and advise the Issuer regarding the rules associated with the exemption, it is up ultimately up to the Issuer to make sure their offering and actions comply with all of the legal requirements for their securities exemption.
The Attorney who drafts the documents and files the notices is generally not involved with raising money from investors. Thus, they have no way of knowing when the Issuer breaks impounds or makes a sale to a resident from a new state, triggering the fifteen (15) day period in which the notice must be filed. If the Attorney is doing the filings on behalf of the Issuer as part of its legal services, the Issuer has a duty to keep the Attorney informed of its progress so that the federal and state notices can be timely filed.
The easiest way to comply with notice filing requirements is to provide your Attorney with a list of states where your investors claim residency before you break impounds. If you continue to raise money beyond that date, then you will need to update your Attorney if you accept a subscription from an investor from a new state so they can file a new state notice within 15 days.
Another common source of securities violations are self-drafted, or “cut and paste” documents. Issuers of securities who copy another’s offering often overlook or are unaware of the required federal and state securities notice filings. If the filings are not timely made, the exemption may not apply, regardless of whether the documents comply with disclosure requirements, or even if the Issuer has followed the rest of the rules for the appropriate exemption (which is unlikely if they cut and pasted someone else’s documents).
Securities practice is not a DIY area of the law for a myriad of reasons. Persons interested in knowing more about the pitfalls should read the article by Syndication Attorneys entitled “The Dangers of DIY Real Estate Syndication.” An Issuer who doesn’t hire an Attorney to draft their offering documents and file their required securities notices with the SEC and state securities agencies, generally does a disservice to their investors and puts the entire investment at risk.
In summary, don’t draft your own offering documents; make sure you have a clear understanding of when a “sale” of a security occurs; and keep your Attorney informed to ensure that the filing deadlines are met. Also, make sure your Attorney is doing the filings as part of their legal services. If not, make sure you know how to do it, or hire an attorney who will do it as part of their services instead. Remember, it’s the Issuer’s responsibility to make sure the offerings complies with the rules for the exemption, and if you are the Issuer, its your reputation and liberty that are at stake.