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2.4 Mixture: 25102(n)
This Section allows a modest form of advertising (a “general announce-
ment”) for a private placement in California only. It is an innovative step in
the right direction. Sales can be made to “qualified” investors only. It has not
been very successful in attracting “angel” money. This is an extremely com-
plicated code section.
NASAA and the SEC are pushing all states to adopt laws similar to
Section 25102(n) in order to allow advertising (the general announcement is
like a tombstone ad) for accredited (“qualified”) investors. Many other
states have adopted “n”-like statutes with its use restricted to sales to ac-
credited investors, rather than the California “qualified” allowance.

3.1 Rule 504: $1 Million Maximum
Rule 504 is discussed above. It is a federal safe harbor for public and private
offerings up to $1 million. Nothing is filed with the SEC other than a Reg. D
form (a simple form showing sales). Rule 504 is much misunderstood: It is
simply no federal jurisdiction. Note that the SEC is proposing to declare se-
curities issued pursuant to Rule 504 to be “restricted” under Rule 144.

3.2 SCOR Offerings
SCOR represents an abdication by the SEC [pursuant to section 3(b) of the
™33 Act and Rule 504], to the states of jurisdiction over public or private of-
ferings of $1 million or less. California and the 49 other states have SCOR
statutes for public offerings. The Form U-7 adopted by NASAA is the re-
quired disclosure document. The “new” form has 124 questions, whereas
the “old” form has 50 questions. In both instances, all questions must be an-
swered. The states vary as to which form to use. California has accepted
both. The U-7 form is not investor friendly. Its emphasis is “legal” rather
than financial. Note that it was written by lawyers, not MBAs. This is a pub-
lic offering, and advertising (approved) is permitted.
In addition, the federal rule provides that securities sold pursuant to
SCOR are not “restricted.” They may be traded. However, this is a serious
trap because some states, particularly California, may well place restrictions
on transfers (see Section 6.2 “Non-issuer Secondary Trading” below), and
finding a “market” (buyers and sellers) may be difficult, if not almost im-
possible. There is a move to have Internet markets established so that sellers
and buyers can “meet on the Internet.” Companies may establish their
“matching” service for owners of the company™s stock; that is, matching
buyers and sellers.
In California, filing with the Commissioner of Corporations is required;
there is “merit review.” Process time varies from two weeks to six months de-
pending on the reviewer and the quality of the applicant and the application.

3.2.1 California SCOR: Public Offering
Used up to $1 million. Suitability is usually imposed and so is a required
minimum amount before funds can be used. Price of stock must be $2 or
more. Use of U-7 as a part of the application and as the disclosure document
is mandatory. Audited financials are usually required if over $500,000 is
being sold. “Reviewed” financials are allowed of up to $500,000. A major-
ity of the board must sign off on the application.
SCOR is used for direct public offerings (DPOs) in many cases. The suc-
cess rate of DPOs is limited. Only a minority of offerors have been able to
raise the minimum requirement for funds. However, issuers with an “affinity
group” have met with the most success, for example, catalog companies.
Stock issued pursuant to the SCOR offering is technically tradable, but
see Section 6.2 “Non-Issuer Secondary Trading” below.
The state filing fee is $2,500 (up to $3,500 if review has complications).
SCOR is not available to out-of-state corporations (unless subject to state
jurisdiction under Section 2115 of the Corporations Code), blind pools, oil
and gas companies, investment companies, and companies reporting to
Legal Primer on Securities Law Issues for Nonlawyers

the SEC. Out-of-state corporations can use Corporate Code Section
25113(b)(1), which adheres to the same requirements and benefits that
SCOR provides.
Legal fees in a SCOR offering can vary from a low of $10,000 to up to
$30,000 or more in a complex application. Average is probably around
$15,000 to $20,000. Again, the legal fees depend on the quality of the
client™s answers to the 50 or 124 questions in the Form U-7. There is no re-
view by the SEC, but California and the other states do review.

3.3 Small Business Rules: Suitability
In the public offering arena, the California Small Business Suitability Rules
are important because they give a break to small businesses. By Rule
260.001(i). the commissioner defines a “small business issuer” as an entity
having annual revenues of less than $12.5 million and is a California corpo-
ration or a foreign (from another state) corporation subject to certain tests
of “doing business” (average property factor, payroll factor, and sales factor
of 25 percent in California, with payroll having to be 50 percent Californian,
and have at least 25 percent of its shareholders in California).
If the entity is a small business and the sale of securities is $5 million or
less, and the offering price is at least $2 per share, the suitability standards,
subject to certain other criteria, for the investors are:

$50,000 income
$75,000 net worth (excluding home, auto and furnishings) or
$150,000 net worth (same exclusions)

provided that $2,500 of stock can be sold to any investor. This rule and its
$2,500 loophole are not available to companies reporting to the SEC
(10Ks,10Qs, etc.).
The $2,500 exemption is important to SCOR offerings in particular. The
average purchase in a SCOR offering is around $1,600, so the exemption fits.

3.4 Regulation A: Public, $5 Million Maximum
The Disclosure Document is either a U-7 or a conventional offering circular.
The latter is similar to a full prospectus. Some clients prefer the offering cir-
cular, even though it is usually a bit more expensive (legal), as it is a decid-
edly better selling document than the U-7.
Regulation A itself (the federal rule) does not require audited financials.
California requires audited financials for an offering without “suitability”

standards, known as an “open permit.” In some instances, as long as there is
sufficiently high suitability, audited financials are not required. Audited fi-
nancials are strongly recommended for two reasons: better reception by the
regulators and better reception by investors. Filing with the SEC is now done
in Washington. Paper filing is still permitted.
SEC filing fees for Reg. A offerings have been eliminated by Congress.
California has a maximum fee of $2,500. Most states handle Reg. A offer-
ings by coordination, that is, if OK with the feds, OK with the state.
California™s commissioner can handle by coordination but is not required to
do so and usually does not.
A Reg. A, due to the very heavy SEC review and the required precision of
offering detail for full disclosure, involves legal fees of $35,000 to $75,000.
Expect as much as twice that from large firms. This does not include filing
fees and blue sky clearing. Blue sky work done by lawyers usually runs about
$2,500 per state (includes filing fees).
Regulation A should return to “fashion” because using it does not result
in being a reporting company subject to the rather onerous provisions of the
Sarbanes-Oxley Act.

3.5 SB-2: Public, No Maximum
SB-2 is the federal form for public offerings and sales of securities of any
amount. It is available to companies that have no more than $25 million in
sales or $25 million in publicly held stock float. It is reviewed in Washington
and must be filed electronically (EDGAR). The filing fee is rather modest and
is scaled on the basis of the amount of the offering.
This is a full-blown registration and involves a detailed prospectus. The
issuer becomes a “reporting company” by use of the SB-2 qualification. For
this reason, many issuers will not use this route because they wish to avoid
being subject to the Sarbanes-Oxley Act.
A registration using SB-2 usually involves an underwriter or investment
banker because DPOs over $5 million are not easy to make successful.
Because an underwriter has counsel (whose fees are paid by the issuing cor-
poration), legal fees for the issuer range from $50,000 to $125,000, and the
underwriter™s counsel fees are about the same. It is clear then that, in the
event there is no underwriter, an SB-2 makes sense only when the issuer
wishes to be a reporting company or is assured of being able to raise the tar-
geted amount of money.
Clearance in California and any state in which offers/sales are made is
also required. (As noted, this is blue skying.) This stock is registered and
therefore not “restricted.”
Legal Primer on Securities Law Issues for Nonlawyers

3.6 S-1: Public, No Maximum
This is the granddaddy of all offerings. It is expensive and is usually used by
listed companies or by emerging Silicon Valley IPO companies. Three years
of audited financials are required.


The disclosure document in a private placement is normally called a PPM.
The PPMs usually are not subject to review by the regulators. The offering
document in a Reg. A offering is called an offering circular. This is reviewed
by the SEC in Washington, DC. Most states accept the SEC review, but
California normally does its own review. An SB-2 (or S-1) uses a prospectus,
which is also reviewed by the SEC in Washington and is reviewed by some
states as well, particularly California.


5.1 Problem
This is a complex area. Integration is a curse on small business because it can
delay sequential offerings. The problem is best explained by an example:
One has a private placement under California Section 25102(f) followed by
another private placement. Unless great care is taken to meet the five tests
(see below), the two private placements could be integrated, causing the of-
ferings to lose their exempt status because more than 35 nonexcluded in-
vestors were involved. This would then require offers of recision to be made
to all the private investors.
The safe harbor period under Reg. D is six months between offerings.
California more or less follows this rule.
Regulation A, pursuant to Rule 251(c), can be used without the six-month
period and also can be followed by a registered offering within six months.
A Section 4(2) and a Rule 506 offering (private) may be followed imme-
diately by a public offering or an intrastate offering [Section 3(a)(11)] within
the six-month period [Rule 502(a)]. This is a most important exception.
Suffice it to say that “integration” is a thorny and dangerous area. See
the rules below.

5.2 Five Tests
When no specific rule applies, such as Rule 506, there are five tests for inte-
gration [Rule 502(a)]. The federal and California rules are similar. The five
tests are:

1. Is the new issue part of a single plan of financing?
2. How much time has passed since the offering?
3. Is it the same type of security (common, preferred, notes)?
4. Is the sale for the same general purpose (use of proceeds)?
5. Is the same type of consideration given? Cash or property?

No particular weight is given to any one of the tests by the federal regu-
lators; however, the courts appear to give the difference in security type the
most weight.

5.3 Safe Harbor: Regulation D
Regulation D [Rule 502(a)] provides a safe harbor of six months between is-
sues. A Reg. A offering can follow another offering without a time span;
however, the amount of $5 million is reduced by any offerings in the prior
year [Rule 251(c)].
Rule 506 allows for a public offering right after the termination of a pri-
vate or public offering. The prior offering under 506 must cease upon filing
with the SEC of an application for a public permit.

5.4 California Rules
In the main, California follows the federal rules. The two factors given the
most weight are (1) part of a single plan of financing and (2) proceeds used
for the same general purpose.
The safe harbor in California is similar to the federal rule (Reg. D) of
six months after completion or before start of an offering [Rule


6.1 Rule 144
Rule 144 applies to resales by shareholders of stock required by means not
involving a registration. The idea is to prevent issuers from selling stock on
an exempt basis to a purchaser who then distributes the stock to others. This
is held to be an underwriting unless Rule 144 is followed.
The rule prescribes holding periods for stock and makes a distinction be-
tween “affiliates” (those who, directly or indirectly, control, or are con-
trolled by, the issuer) and noncontrol persons.
To use the rule, the issuer must either be a reporting company (10Ks,
10Qs, etc.) that is current in its filings or a company that makes publicly
Legal Primer on Securities Law Issues for Nonlawyers

available the information required by Rule 15c2-11 (Exchange Act rules).
This information covers the basic identity of the issuer, its products, man-
agement, financials, and so on.
The rule, if followed, provides a safe harbor for the selling shareholders;
that is, the seller will not be an underwriter illegally selling securities.
The holding period under Rule 144, shortened in 1996, is now:

For nonaffiliates:
(A) One year from acquisition from the issuer and/or affiliate one may
“dribble” each three months the greater of: up to 1 percent of the amount of
stock of the issuer as shown in its most recently published balance sheet; or
the average weekly reported volume of trading in the security on all national
exchanges and Nasdaq during the two calendar weeks preceding the sale.
(B) After two years one may sell without restriction [Rule 144(k)].

For affiliates:
Same rule as A above; B does not hold.
Rule 144 is very complex”whole volumes are written about it. There
are rules and rulings as to the measure of the time period, “tacking” the
holding periods, affiliates, and so on. One should not act without consulting
an attorney experienced in this field.

6.2 Nonissuer “Secondary” Trading (by a Shareholder


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