QUESTION: What notices must be filed with securities agencies for an exempt real estate syndication under Regulation D, Rule 506?

The following answer is involved, but well worth your time and attention to keep you out of trouble where the sales of securities is concerned.

Federal Securities Notices

A “safe harbor” exemption from registration is granted to the “issuer” of securities when an offer and sale of securities complies with the specific requirements of Regulation D, Rules 504, 505, or 506 under the federal Securities Act of 1933. The safe harbor exempts an issuer from both:

  • Registration requirements under the Securities Act of 1933
  • 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 on their own behalf. If you are reading this article, this probably means you are an issuer or are contemplating becoming one. An issuer could be an individual or an entity whose officers, directors or employees are selling securities on behalf of the company. The term issuer does not apply to an individual who is seeking compensation or commission for selling securities on behalf of others, which generally requires a securities license (but that’s another topic altogether and beyond the scope of this article).

Federal Filing Requirements—Form D

What Constitutes a Sale?

One of the requirements most often overlooked by an issuer who otherwise would be entitled to claim the safe harbor exemption is 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.” (See SEC Publication, Filing and Amending a Form D Notice, A Compliance Guide for Small Entities and Others http://www.sec.gov/info/smallbus/secg/formdguide.htm.)

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 accepted by the issuer, the date “impounds are broken” (when the minimum offering amount is raised) 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 his or her money back because it has been spent to further the objectives of a real estate acquisition or business.

What is the Purpose of the Form D Filing?

The purpose of the Form D is to notify the SEC that securities are being sold to U.S. investors and giving it information about the offering and jurisdiction over the issuer in the event the agency wishes to conduct an audit or receive a complaint regarding potential securities violations. If the Form D isn’t filed within the specified time, the issuer exemption may not apply to the offering. Further, the issuer may be found to have engaged in the unlicensed sale of securities and/or selling unregistered securities. Either case 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, the attorney 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 also are many attorneys who will draft the offering documents, but leave it to the issuer to file its own notices.

If the Form D is not filed in a timely manner, 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.

State “Blue Sky” 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 as a percentage of an investor’s total net worth, or a state securities agency’s pre-approval of a securities offering. Most state securities agencies simply require that the issuer send them a copy of the Form D that was filed with the SEC, along with payment of a required filing fee. This is called a Blue Sky notice.

The purpose of these Blue Sky notice filings is to notify the state securities agencies when a security has been sold to one or more or their residents and giving those states 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 have occurred.

If the Blue Sky notice isn’t filed within the specified time (usually 15 days from the first sale in that state), the state may disallow the federal exemption, and the issuer may be found to have engaged in the unlicensed sale of securities as well as selling unregistered securities within the state. That could leave the issuer open to prosecution by the state’s Attorney General or in its state courts for violating its state laws. (State laws may vary as to this timeframe and the type of notice required.)

Blue Sky 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. Beware New York, however, as its Blue Sky filing fees can be as much as $1900 for an offering of more than $500,000.

Other Federally Exempt Offerings

Offerings qualifying for an exemption under Rule 147, or Regulation D, Rules 504 or 505 may require much more extensive filings with the states, 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”). Call us even if you are thinking of doing an Intrastate Offering, as we may be able to offer you some guidance.

Consequences for Failure to Timely File

Most states won’t allow late filings of securities notices. If an issuer fails to file the state notice within the required timeframe, there may not be an opportunity to fix it later. In that case, the issuer is operating on a wing and prayer for the entire duration of the investment. If something goes wrong and an investor complains or if the state learns of the sale of securities within its jurisdiction without the required Blue Sky filing, it could elect to prosecute the issuer at any time.

As a matter of public policy, a company cannot indemnify the issuer for securities violations. 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 (such as misrepresentation and fraud), subjecting the issuer to further liability and putting the entire investment at risk, or that other state securities agencies may also file suit against the issuer.

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

People who try to draft their own offering documents may not even realize that federal and state filings are required for them to claim the exemption and inadvertently end up with no exemption! On the flipside, 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 Blue Sky notices can be timely filed!!! Make sure you don’t fall into either of those traps.

Issuers need to understand that compliance with the Form D and Blue Sky 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 ultimately up to the issuer to make sure its offering and actions comply with all of the legal requirements for its securities exemption—including the required filings.

The attorney who drafts the documents and files the Form D and Blue Sky notices is generally not involved with raising money from investors. Thus, he or she has no way of knowing when the issuer breaks impounds or makes a sale to a resident from a new state, triggering the typical 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 Form D and Blue Sky notices can be timely filed.

The easiest way to comply with federal and Blue Sky notice filing requirements is to provide your attorney with a list of states where your investors claim residency before you break impounds and use their money. 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 the attorney can file a new state notice within the required timeframe.

Another common source of securities violations includes 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 Blue Sky 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 the issuer cut-and-pasted someone else’s documents).

Don’t Try it Yourself

As you can see, Securities practice is not a DIY area of the law for this and a myriad of other reasons.

Persons interested in knowing more about the pitfalls should request the Syndication Attorneys, PLLC article entitled “The Perils of Drafting Your Own Syndication Documents,” or read these two blog postings on our website: “7 Dangers of DIY Real Estate Syndication” and “More Perils of DIY Real Estate Syndication.” An issuer who doesn’t hire an attorney to draft the offering documents and file the required Form D and Blue Sky notices generally does a disservice to its investors and puts all of its investors 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 Form D and Blue Sky filing deadlines are met. Also, make sure your attorney is doing the filings as part of its legal services. If not, make sure you know how to do it, or hire an attorney who will do it as part of the firm’s services instead. Remember: it’s YOUR responsibility to make sure the offering complies with the rules for the exemption, and if YOU are the issuer, by failing to file, you put your reputation and liberty—and your investor’s funds—at stake.

NOTE: 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 formed to address your specific questions or matters.

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