Traps for the Unwary: Selling Stock in Your Company

November 28, 2012

Unless a specified exception applies, the Securities Act of 1933 requires registration of any security sold (whether debt and equity).  The most common exception is an offering of securities “not involving any public offering.”  Failure to fall within one of the exceptions can result in a company or those individuals that promoted the sale of the company’s securities to be liable to give the investors back their money with interest (i.e. investors can rescind the transaction) and could subject them to other civil and criminal penalties under state or federal law.

This means that you cannot advertise the offering or post information about the offering on the internet without registering (i.e. becoming a public company).  In general, you must have a pre-existing relationship with the persons buying your stock. The precise limits of this private offering exemption are uncertain.

Securities and Exchange Commission Regulation D provides a reasonably certain safe harbor. If you comply with its rules, then your offering will be lawful.  It is not simple to comply with Regulation D but it is much, much easier than becoming a public company.  There are three rules (Rule 504, Rule 505 and Rule 506).  The most commonly used is Rule 506.

Under Rule 506:

  • You can raise an unlimited amount of capital;
  • You cannot use general solicitation or advertising to market the securities;
  • You can sell securities to an unlimited number of accredited investors and up to 35 other purchasers. Under Rule 506, however, all non-accredited investors, either alone or with a purchaser representative (like a CPA), must be deemed sophisticated.
  • Purchasers receive restricted securities which means that purchasers may not freely trade the securities in the secondary market after the offering.

An accredited investor is, generally, either (1) an institution or (2) a natural person who has a residence exclusive net worth of $1 million or more or an income of $200,000 or more ($300,000 joint).

Very importantly, Rule 506 offerings are not subject to most state securities law registration and qualification requirements.

There are additional rules.  A good securities attorney can guide you through this process.

The JOBS Act signed into law in April provides that the prohibition against general solicitation or general advertising contained in Regulation D will not apply to offers and sales of securities made pursuant to Rule 506, provided that all purchasers of the securities are accredited investors. It further requires the issuer “to take reasonable steps to verify” that purchasers of the securities are accredited investors, using such methods as determined by the Commission.

On August 29, the Commission agreed to a proposed rule. To read NSBA’s comments on this proposed rule, click here. When that rule is finalized, companies will be able to advertise Rule 506 offerings or post the offerings on the internet.  Although the JOBS Act required that the rule be out by July 5, it is not clear when the SEC will release a final rule.  Nor is it clear what the final rule will look like.  Many opponents to the JOBS Act are pressing for the verification rules to be very onerous.  The resignation of SEC Chairman Mary Schapiro effective December 14 may delay the issuance of the rule since it may prove difficult to get a three member majority (of four remaining commissioners) to support any particular approach.

Please click here to read Traps for the Unwary: Arrest Records & Employment.

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For questions, please contact NSBA General Counsel David R. Burton at

NSBA cannot give legal advice with respect to specific situations.