TLDR
The three areas where private placements fail enforcement review are general solicitation violations, accredited investor verification failures, and integration with prior or subsequent offerings. Most enforcement actions start with one of these three issues. Structure every placement assuming it will be reviewed.
The Enforcement Perspective on Private Placements
During my time as a Staff Attorney in the SEC Division of Enforcement, private placement cases were among the most common on our docket. The pattern was remarkably consistent: an issuer raises capital under Regulation D, fails to comply with one or more conditions of the exemption, and the securities are later determined to have been sold in violation of Section 5 of the Securities Act. The consequences are severe, including investor rescission rights, enforcement action, and personal liability for officers and directors.
What made these cases relatively straightforward to build was that the exemption conditions are binary. Either the issuer engaged in general solicitation or it did not. Either the investors were accredited or they were not. Either the Form D was timely filed or it was not. There is very little room for interpretive argument once the facts are established, which is why compliance at the outset is so much more valuable than defense after the fact.
The enforcement perspective I developed during my SEC tenure now informs how I advise issuers on structuring their private placements. Every element of the offering structure should be designed to create a clear, documentable record of compliance with each condition of the exemption. This is not about form over substance. It is about creating the evidence that demonstrates substantive compliance if the offering is ever examined by enforcement.
Regulation D Mechanics That Matter
Regulation D provides a safe harbor framework for private placements under Sections 3(b) and 4(a)(2) of the Securities Act. The most commonly used provision is Rule 506, which comes in two variants: Rule 506(b) and Rule 506(c). Understanding the mechanical differences between these two rules is essential because choosing the wrong one, or failing to comply with the conditions of the chosen rule, destroys the exemption entirely.
Rule 506(b) is the traditional private placement exemption. It prohibits general solicitation and general advertising, permits sales to an unlimited number of accredited investors and up to 35 non-accredited but sophisticated investors, requires information delivery to non-accredited investors, and does not mandate specific accredited investor verification procedures. The issuer may rely on investor self-certification of accredited status, provided the issuer has no reason to believe the certification is false.
Rule 506(c), added by the JOBS Act in 2013, permits general solicitation and general advertising but restricts sales exclusively to accredited investors and requires the issuer to take "reasonable steps to verify" that all purchasers are accredited investors. The verification requirement is the key operational difference. Under 506(c), investor self-certification is not sufficient. The issuer must obtain independent evidence of accredited status, which may include reviewing tax returns, bank statements, brokerage statements, or obtaining written confirmation from a registered broker-dealer, registered investment adviser, licensed attorney, or certified public accountant.
General Solicitation: Where Most Violations Occur
In my enforcement experience, general solicitation violations accounted for the largest category of Regulation D failures. The concept is straightforward in principle: an issuer using Rule 506(b) cannot make any form of public communication that conditions the market for the offering or solicits interest from persons with whom the issuer does not have a pre-existing substantive relationship. In practice, this prohibition creates compliance challenges that many issuers fail to navigate.
The pre-existing substantive relationship requirement has two components: the relationship must pre-date the offering, and it must be substantive rather than nominal. A substantive relationship is one in which the issuer or its agent has sufficient information about the potential investor to evaluate whether the investor is accredited and whether the investment is suitable. A large email list, a social media following, or a database of conference attendees does not create pre-existing substantive relationships merely because the issuer had prior contact with these individuals.
Modern communications create particular risk for general solicitation violations. A CEO who tweets about "exciting fundraising developments," a company that posts LinkedIn content about its "growth capital strategy," or a founder who discusses the offering at a public conference is engaging in general solicitation. The intent does not matter. If the communication reaches persons who are not pre-existing substantive relationships and the communication is designed to, or has the effect of, conditioning the market for the offering, the general solicitation prohibition has been violated and the Rule 506(b) exemption may be destroyed.
Accredited Investor Verification
The accredited investor verification requirement under Rule 506(c) represents a significant operational burden that many issuers underestimate. The rule requires "reasonable steps to verify" accredited status, and the SEC has provided non-exclusive guidance on what constitutes reasonable steps. For income-based accreditation, this may include reviewing IRS forms such as W-2s, 1099s, K-1s, or filed tax returns for the two most recent years. For net worth-based accreditation, this may include reviewing bank statements, brokerage statements, and credit reports.
Third-party verification provides an alternative to direct financial document review. A written confirmation from a registered broker-dealer, SEC-registered investment adviser, licensed attorney, or CPA that the person has taken reasonable steps to verify accredited status within the prior three months satisfies the rule. This approach is often preferred because investors are more comfortable sharing financial information with their own advisors than with the issuer.
The enforcement risk in accredited investor verification is not limited to situations where a non-accredited investor purchases securities. The risk also includes situations where the issuer's verification process is superficial or perfunctory. If enforcement examines an offering and finds that the issuer relied on checkbox certifications rather than taking reasonable steps to verify, the exemption is at risk regardless of whether all investors actually were accredited. The verification requirement is a process obligation, not merely a results obligation.
Bad Actor Disqualification
Rule 506(d) disqualifies an issuer from relying on Rule 506 if any "covered person" has experienced a disqualifying event. The scope of covered persons is deliberately broad: it includes the issuer, any predecessor of the issuer, any affiliated issuer, any director, executive officer, or other officer participating in the offering, any general partner or managing member of the issuer, any beneficial owner of 20% or more of the issuer's outstanding voting equity securities, any promoter connected with the issuer, any compensated solicitor, and any general partner, director, executive officer, or managing member of any compensated solicitor.
Disqualifying events include criminal convictions in connection with the purchase or sale of securities, SEC cease-and-desist orders involving scienter-based violations, final orders from state securities regulators, certain SRO disciplinary actions, SEC disciplinary orders, and suspension or expulsion from membership or association with an SRO. The look-back period varies by event type but generally covers the five- or ten-year period prior to the first sale.
The due diligence obligation to identify disqualifying events is on the issuer. This requires searching SEC enforcement records, FINRA BrokerCheck, state regulatory databases, and court records for every covered person associated with the offering. Failure to conduct this due diligence does not excuse the disqualification. If a covered person has a disqualifying event that the issuer failed to discover, the exemption is unavailable regardless of the issuer's lack of knowledge.
Form D Filing and Compliance
Form D is a notice filing that must be submitted to the SEC on EDGAR within 15 calendar days after the first sale of securities in a Regulation D offering. The form collects basic information about the issuer, the offering terms, the exemption being claimed, and the identity of certain executive officers and promoters. While Form D filing is technically a condition of the Regulation D rules, the SEC has historically taken the position that failure to file does not automatically destroy the federal exemption.
However, Form D compliance has significant practical consequences beyond the federal exemption question. Many states condition their own notice filing requirements on timely federal Form D filing. Late or missing Form D filings can trigger state enforcement action, create complications for future offerings, and generate negative attention from the SEC staff. Additionally, institutional investors and their counsel routinely check EDGAR for Form D filings as part of their due diligence, and the absence of a filing raises questions about the issuer's compliance posture.
Form D amendments are required for material changes in the information reported, including increases in the offering amount, changes in the minimum investment, and changes in executive officers or promoters. Annual amendments are also required for ongoing offerings. The amendment obligation continues for the life of the offering, and many issuers fail to file required amendments because they do not have systems in place to track the triggering events for amendment filings.
The Integration Doctrine
The integration doctrine is one of the most significant analytical frameworks in private placement compliance, and it is one of the least well understood. Integration asks whether two or more offerings should be treated as a single offering for purposes of determining whether an exemption is available. If offerings are integrated, they must collectively satisfy all conditions of the applicable exemption.
The traditional five-factor test examines whether the offerings are part of a single plan of financing, whether they involve the same class of securities, whether sales are made at or about the same time, whether the same type of consideration is received, and whether the offerings are made for the same general purpose. In 2020, the SEC adopted new integration principles under amended Rule 152 that provide additional safe harbors and modernize the analysis, but the fundamental concept remains: offerings that are economically part of the same capital raise should be analyzed together.
For issuers conducting multiple capital raises in close succession, integration analysis is essential. A Rule 506(b) offering conducted six months after a Rule 506(c) offering to some of the same investors for the same general corporate purposes creates integration risk. If the offerings are integrated, the combined offering must satisfy the more restrictive conditions of both rules, which may be impossible. Careful structuring and documentation of the business rationale for separate offerings is the primary defense against integration.
Emerging Industry Private Placement Challenges
Cannabis companies conducting private placements face a unique set of challenges that arise from the conflict between state legality and federal illegality. The PPM must adequately disclose the risks of federal enforcement action, banking restrictions, IRC Section 280E tax treatment, and the inability to deduct ordinary business expenses. Investor suitability analysis for cannabis investments goes beyond standard accredited investor qualifications because the investment involves participation in an activity that remains illegal under federal law.
AI companies raise capital through private placements at every stage of development, from pre-revenue startups to mature companies seeking growth capital. The critical compliance issue for AI company PPMs is the accuracy of technology capability representations. Enforcement views overstated technology claims in offering documents as potential securities fraud, regardless of whether the company's management believed the claims were accurate. The PPM should clearly distinguish between current capabilities, planned development, and aspirational goals.
Cryptocurrency and digital asset companies face heightened scrutiny in private placements because the offering itself may involve the sale of investment contracts under the Howey test. The PPM must include a thorough analysis of whether the token or digital asset constitutes a security, the regulatory implications of that classification, and the risks associated with evolving regulatory standards. Additionally, AML/KYC compliance for crypto offerings requires sophisticated identity verification systems that go beyond standard subscription agreement representations.
10 Key Points
- 1.The single most common enforcement trigger in private placements is general solicitation. If the offering reaches anyone who is not a pre-existing substantive relationship, the exemption may be destroyed.
- 2.Regulation D Rule 506(b) prohibits general solicitation but does not require accredited investor verification. Rule 506(c) permits general solicitation but requires reasonable steps to verify accredited investor status.
- 3.The integration doctrine can collapse multiple offerings into a single offering, destroying the exemption for all of them. Timing, investor overlap, use of proceeds, and the nature of the securities are all factors.
- 4.Bad actor disqualification applies to the issuer, its predecessors, affiliated issuers, directors, officers, general partners, managing members, 20% beneficial owners, promoters, solicitors, and their associates.
- 5.Form D must be filed within 15 days after the first sale of securities, but many issuers file late or not at all, creating enforcement exposure and potentially affecting the availability of the exemption in certain states.
- 6.The SEC staff examines private placement memoranda for consistency with other company communications, including websites, social media, press releases, and investor presentations.
- 7.Cannabis private placements face unique challenges because federal illegality creates investor suitability concerns that go beyond standard accredited investor qualifications.
- 8.AI company private placements require careful attention to technology capability representations in the PPM because enforcement views overstated technology claims as potential securities fraud.
- 9.State blue sky compliance remains essential even when federal registration is exempt under Regulation D. Each state has its own notice filing requirements, fees, and timing obligations.
- 10.Flat-fee private placement counsel eliminates the economic pressure to cut corners on investor verification, PPM preparation, and state compliance, which are the areas where enforcement exposure concentrates.
Frequently Asked Questions
What is a private placement?
A private placement is a sale of securities that is exempt from SEC registration under the Securities Act of 1933. The most common exemption framework is Regulation D, which provides Rules 504, 506(b), and 506(c) as safe harbors for issuers raising capital without registering the securities with the SEC. Private placements are sold to a limited number of sophisticated or accredited investors rather than to the general public.
What is the difference between Rule 506(b) and Rule 506(c)?
Rule 506(b) prohibits general solicitation and general advertising but does not require the issuer to take specific steps to verify accredited investor status. The issuer may rely on investor self-certification. Rule 506(c) permits general solicitation and general advertising but requires the issuer to take reasonable steps to verify that all purchasers are accredited investors, which typically requires reviewing tax returns, bank statements, or obtaining written confirmation from a qualified third party.
What is general solicitation and why does it matter?
General solicitation is any communication that offers securities to the public at large rather than to persons with whom the issuer or its agents have a pre-existing substantive relationship. General solicitation includes public advertising, mass mailings, social media posts about the offering, and presentations at conferences where attendees have not been pre-qualified. Under Rule 506(b), any general solicitation destroys the exemption.
What qualifies as an accredited investor?
Under SEC rules, an accredited investor includes individuals with annual income exceeding $200,000 (or $300,000 jointly with a spouse) in each of the two most recent years with a reasonable expectation of the same in the current year, or individuals with net worth exceeding $1 million excluding primary residence. Certain entities, including banks, insurance companies, and investment companies, also qualify.
What is a private placement memorandum (PPM)?
A PPM is the disclosure document provided to prospective investors in a private placement. While Regulation D does not require a specific disclosure document for offerings to accredited investors only, a well-prepared PPM is essential for legal protection. It should include a description of the business, risk factors, terms of the offering, use of proceeds, management information, and financial statements.
How does the integration doctrine work?
The integration doctrine allows the SEC to treat multiple separate offerings as a single offering for the purpose of determining whether an exemption is available. If two offerings are integrated, the combined offering must satisfy all requirements of the applicable exemption. Factors include the timing of the offerings, whether they are part of a single plan of financing, whether the same type of consideration is involved, and whether the offerings are for the same general purpose.
What is bad actor disqualification?
Rule 506(d) disqualifies an issuer from relying on Rule 506 if certain covered persons have specified criminal convictions, regulatory orders, SEC disciplinary actions, or other disqualifying events. Covered persons include the issuer, its directors, executive officers, general partners, managing members, 20% equity owners, and any compensated solicitor or its general partners, directors, or executive officers.
What are the Form D filing requirements?
Form D is a notice filing with the SEC that must be filed electronically on EDGAR within 15 calendar days after the first sale of securities in a Regulation D offering. The form includes information about the issuer, the offering, and the exemption being claimed. While failure to file Form D does not automatically destroy the federal exemption, it creates enforcement exposure and may affect state blue sky compliance.
Do state securities laws still apply to Regulation D offerings?
Yes. While Rule 506 offerings preempt state registration requirements, states retain the authority to require notice filings, collect fees, and take enforcement action for fraud. Each state has its own blue sky filing requirements, and failure to comply can result in state enforcement action, investor rescission rights, and complications for future offerings.
What are the risks of a failed private placement exemption?
If a private placement exemption fails, the securities were sold in violation of Section 5 of the Securities Act, which requires registration. Consequences include investor rescission rights (the right to demand their money back), SEC enforcement action, state enforcement action, and potential personal liability for officers and directors who participated in the unregistered offering.
How do cannabis companies handle private placements?
Cannabis companies face unique private placement challenges including enhanced risk factor requirements related to federal illegality, banking and capital flow restrictions, investor suitability concerns beyond standard accredited investor qualifications, the need to disclose the impact of IRC Section 280E on financial projections, and state-by-state regulatory differences that affect the company's operations and risk profile.
What should AI companies include in their PPM?
AI company PPMs should include accurate descriptions of current technology capabilities (not aspirational), data governance and privacy compliance status, intellectual property ownership and protection, key personnel dependencies, regulatory risk factors for AI-specific legislation, and clear disclaimers distinguishing between current functionality and planned development. Overstated technology claims in a PPM create securities fraud exposure.
What is a subscription agreement?
A subscription agreement is the contract between the investor and the issuer that governs the purchase of securities in a private placement. It typically includes investor representations and warranties about accredited investor status, acknowledgment of risks, investment intent, and transfer restrictions. A well-drafted subscription agreement provides evidence of the investor's qualifications and protects the integrity of the exemption.
Can I use social media to promote my private placement?
Under Rule 506(b), promoting a private placement on social media constitutes general solicitation and will destroy the exemption. Under Rule 506(c), general solicitation is permitted, but all purchasers must be verified accredited investors. Even under 506(c), social media communications about the offering must comply with antifraud provisions and must not contain misleading statements about the investment.
What due diligence should investors conduct before investing in a private placement?
Investors should review the PPM carefully, verify the issuer's corporate existence and good standing, check the backgrounds of management and principals (including FINRA BrokerCheck and SEC EDGAR searches), review any available financial statements, understand the use of proceeds, evaluate the exit strategy, and consult with their own legal and financial advisors before making an investment decision.
How does a flat-fee arrangement benefit private placement issuers?
Private placements involve multiple workstreams including PPM preparation, subscription agreement drafting, investor verification, Form D filing, state blue sky compliance, and closing mechanics. Under hourly billing, the cost uncertainty can pressure issuers to cut corners on any of these workstreams, creating enforcement exposure. Flat-fee arrangements ensure comprehensive compliance without economic pressure to reduce the scope of counsel's work.
What is Regulation A+ and how does it differ from Regulation D?
Regulation A+ provides two tiers of exemption for public offerings: Tier 1 allows offerings up to $20 million in a 12-month period, and Tier 2 allows offerings up to $75 million. Unlike Regulation D, Regulation A+ permits general solicitation and advertising, does not restrict sales to accredited investors, and results in freely tradeable securities. However, Regulation A+ requires SEC qualification of an offering statement, which involves a review process similar to registration.
What is the role of a placement agent in a private placement?
A placement agent is a broker-dealer that assists the issuer in identifying potential investors and facilitating the offering process. The placement agent must be registered with FINRA and is subject to suitability obligations, due diligence requirements, and compensation disclosure rules. Using an unregistered placement agent or paying transaction-based compensation to a non-broker-dealer is a significant compliance violation.
What happens if an investor is later found not to be accredited?
If a non-accredited investor purchases securities in a Rule 506(b) offering, the exemption may be preserved if the issuer made a reasonable determination at the time of sale that the investor was accredited. Under Rule 506(c), the issuer must have taken reasonable steps to verify accredited status, and failure of verification destroys the exemption. In either case, the non-accredited investor has potential rescission rights.
How do I structure a private placement for a cryptocurrency project?
Cryptocurrency private placements require careful structuring including thorough Howey test analysis of the token or digital asset, clear disclosure of regulatory uncertainty, accurate description of the technology and its development stage, compliance with AML/KYC requirements, use of a SAFT (Simple Agreement for Future Tokens) or other appropriate instrument, and state blue sky compliance. The PPM must address the unique risks of digital asset investments with specificity.
This article was written by Frederick M. Lehrer, Esq., a former SEC Division of Enforcement Staff Attorney and Special Assistant United States Attorney (Southern District of Florida) with over 30 years of securities law experience. Florida Bar No. 888400.