Non-Accredited Investors & Integration of Related Offerings

By Keith Baldwin

A reader recently wrote to me asking what I thought of the following financing arrangement:

I want to form a company that would have multiple subsidiaries, each doing a Rule 504 SCOR (Small Corporate Offering Registration) offering, where all investors would be non-accredited.  When the maximum of $1 million is reached, a new subsidiary would launch another 504 to all non-accredited investors and raise another $1 million, and so on.  However, the raise would need to be restricted to just the SCOR states.  One could incorporate additional issuing entities in other states and continue this same process with everything rolling up under the parent company.  This potentially solves the no solicitation rule and the pre-existing relationship issue.

We could do 6 coordinated SCOR offerings covering 37 States and should be able to issue one SCOR offering for each subsidiary (each subsidiary raising $1million).

My response was that this plan raised serious securities regulatory issues.

Rule 500(f), at the very beginning of Reg D, states a principle that is a linchpin of the SEC’s exemption structure.  It reads as follows:

(f) In view of the objectives of Regulation D and the policies underlying the Act, Regulation D is not available to any issuer for any transaction or chain of transactions that, although in technical compliance with Regulation D, is part of a plan or scheme to evade the registration provisions of the Act. In such cases, registration under the Act is required. (Emphasis supplied.)

The SEC uses Rule 500(f), as well as its “integration” doctrine under Rule 502(a), to look through serial or concurrent offerings of the type suggested, especially where it appears that an issuer is trying to avoid the dollar limits or the limits on the number or types of investors.   The state regulators have a similar approach.  The integration doctrine looks at whether there is a common plan of financing that unites various offerings, whether the offerings are concurrent or serial, and provides a conditional safe harbor only where offerings are more than six months apart.  That rule should be read and interpreted very carefully, along with the SEC No-Action Letters on that topic.

There is a further risk if proceeds of a subsequent offering are used to refinance or “prop up” an unsuccessful prior offering.  The securities regulators are quick to call those kinds of arrangements “Ponzi schemes,” whether the term actually fits the situation or not.

In short, anyone looking at linking together offerings by different subsidiaries of the same company in order to avoid the restrictions of various exemptions should know this:  the securities regulators have seen it all, they take a dim view of anything that looks like a “plan or scheme to evade” the securities laws, and they back up their views with enforcement actions when justified by the facts.

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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