In May 2013, National Biotech Corporation generally advertises that it will make a $4 million offering of stock in June. National makes the offering as advertised and, ten days after the first sale, notifies the Securities and Exchange Commission (SEC)

Question

All buyers of the stock are given material information about the company, its business, and the stock. Before the end of the year, the offering is completely sold out. The buyers include forty unaccredited investors and fifty accredited investors. National does not register the offering. The SEC files a suit against National, seeking civil sanctions on the ground that this offering was not exempt from registration. National argues that the applicable exemption is Rule 505 of Regulation D of the Securities Act of 1933 and that because of this exemption, any resale of the stock is also exempt. Who is correct?

Answer 1

The SEC is correct on both points. To be exempt under Rule 505 of Regulation D of the Securities Act of 1933, a private, noninvestment company offering for less than $5 million in any twelve-month period may be sold to any number of accredited investors but no more than thirty-five unaccredited investors, an offering must not be generally advertised or solicited, and the SEC must be notified of the sales. If a sale involves any unaccredited investor, all investors must be given material information about the offering company before the sale. Precautions must be taken against nonexempt, unregistered resales. In this problem, National's offering complies with all of the requirements except the following: the offering is generally advertised, and the stock is sold to forty unaccredited investors. This is enough to remove National's offering from the exemption. Even if the offering were exempt from registration, however, resales might not be exempt. Securities initially exempt under Rule 505 are restricted securities. This means that they must be registered before resale unless they qualify under a Rule 144 or Rule 144A exemption.