Rule 504: Everything You Need to Know

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The 1929 stock market crash was the catalyst for federal laws designed to protect investors from companies that made dishonest claims about the financial stability of their businesses. The Securities Act of 1933 requires companies wanting to sell securities to complete and file documents containing essential information potential stockholders need to evaluate a stock offering.

Rule 504 is one of several federal exemptions to the requirement of filing these registration documents under federal law, but states can make their own registration laws companies must follow for every state in which they trade. A Maryland business attorney can explain how Rule 504 could apply to your business and your potential offerings.

Potential Ways to Raise Capital for Your Company

Unless you were born with a silver spoon in your mouth, you will likely need to raise capital at some point or at multiple points to launch and grow your business. Undercapitalization gets blamed for many of the new business failures that happen every year.

You might try to eke out an existence with “shoestring” funding, meaning, using up your personal savings and maxing out your credit cards. These two items are particularly risky funding options because you could face personal financial doom if your company fails.

Asking for loans from your relatives and friends is seldom successful in raising much working capital. You might look for other individuals who could share the risk with you, like a new partner or investor, but you must give up a chunk of the ownership of your company, and usually significant control.

Other funding options include taking out a business loan or offering to sell shares in your company in exchange for much-needed capital. Most of the funding options fall under the regulations of the federal Securities and Exchange Commission (SEC) because these transactions usually involve securities like bonds, options, or stocks.

Before selling securities, you must comply with the SEC registration regulations and with the “blue-sky” statutes of each state where you plan to offer the stocks, bonds, or options. If, however, you fall within an exception to the SEC’s registration requirements, you will not have to register your offering with the SEC or comply with the federal rules.

Rule 504 – An Exception to SEC Registration Rules

The SEC added exceptions to their registration guidelines in Regulation D. Regulation D includes the exceptions and safe harbors of Rules 504, 505, 506(b), and 506(c). This article focuses on the Rule 504 exemption.

Originally, if you wanted to raise up to $1 million in offerings within a 12-month block, you did not have to register the offering with the SEC. In 2016, the maximum increased to $5 million within a 12-month period. The SEC specifies in Rule 504 the exemption is not available to every company.

Typically, you cannot solicit to the general public to capture investors if you wish to avail yourself of Rule 504. In other words, you cannot advertise openly about the offering, but you could contact parties already involved with the company. Some types of companies not eligible for a Rule 504 registration exemption include:

• Investment companies
• Businesses that have declared their interest in merging or getting acquired by another company
• Businesses classified as “bad actors” and ineligible for Rule 504 exceptions
• Exchange Act reporting companies

Also, the purchasers of stock in a Rule 504 offering receive “restricted” securities. Restricted securities in this situation must get registered if the buyer wants to sell them within six months or a year.

If your company wants to offer securities under Rule 504, you will not have to register the offering of securities with the SEC, but you must file a “Form D” with the SEC as soon as you sell these securities. Form D requires you to provide notice of these details:

• The names and addresses of the company’s promoters, directors, and executive officers
• Some information about the offering

Form D does not require much additional information about the company other than those two items. You may file Form D electronically.

Qualifying under Rule 504 does not eliminate other requirements of federal law. You still need to provide enough information to potential securities purchasers to comply with the federal securities antifraud provisions. You could run afoul of the antifraud laws if your information contains false or misleading statements or omits information such that the information you provide to potential investors is false or misleading.

Also, your state securities regulations might require registrations of securities offerings even if you are eligible for Rule 504 treatment under federal law.

Get Help From an Experienced Maryland Business Attorney

Federal and state securities regulations are sophisticated. Violations can carry severe penalties. You will want to seek guidance from a Maryland business attorney before relying on Rule 504. Contact Steve for more information before registering your securities.