Private Offering Exemption under Arizona Securities Law


Private Offering Exemption under Arizona Securities Law

Please note that, while this article accurately describes applicable law on the subject covered at the time of its writing, the law continues to develop with the passage of time. Accordingly, before relying upon this article, care should be taken to verify that the law described herein has not changed.
This article summarizes the private offering exemption available under Arizona securities laws, including A.R.S. § 44-1844(A)(1) and Arizona Administrative Code (“A.A.C.”) § 14-4-126, which exempt securities from certain registration requirements, including A.R.S. §§ 44-1841 (securities) and 44-1842 (dealers or salespersons).

In either instance, it is important to note that the burden of proving the private offering exemption is on the party claiming the exemption. See A.R.S. § 44-2033; State v. Baumann, 125 Ariz. 404, 412, 610 P.2d 38, 48 (1980); A.A.C. § 14-4-126(F)(1).

I. Private Offering Exemption under A.R.S. § 44-1844(A)(1). 

A.R.S. § 44-1844(A)(1) provides a statutory exemption from registration, including the requirements set forth in A.R.S. §§ 44-1841 and 44-1842, for any “[t]transactions by an issuer not involving any public offering.” A.R.S. § 44-1844(A)(1). In other words, issuer’s private offerings are exempt from registration under A.R.S. § 44-1844(A)(1).

The private offering exemption is only available to an issuer. Id. In general, an issuer is a “person who issues or proposes to issue any security.” A.R.S. § 44-1801(13).

Further, the private offering exemption is only available for offerings made by issuers without any advertising or general solicitation to a limited number of sophisticated investors with access to information that would ordinarily be included in a registration statement. Arizona Corporation Commission, Raising Capital: Overview of Registration of, and Exemptions from Registration for, Securities Offerings (“Raising Capital”), August 2010 at 5. When the security qualifies as a private offering, so too does the issuer. If, however, the issuer “is engaged principally and primarily in the business of making a series of private offerings . . . [which] means in excess of four private offerings within, from, or outside Arizona in any consecutive 12-month period,” the issuer cannot use the private offering exemption and must register as a dealer or salesperson or qualify for a different exemption. A.A.C. § 14-4-104(4).

An issuer trying to use the private offering exemption may rely upon Arizona case law interpreting A.R.S. § 44-1844(A)(1) and federal case law interpreting its federal counterpart, 15 U.S.C. § 77d(2), which provides that 15 U.S.C. § 77e does not apply to “transactions by an issuer not involving any public offering.” 15 U.S.C. § 77d(2).

Arizona courts have yet to interpret the private offering exemption under A.R.S. § 44-1844(A)(1). However, federal courts have adopted a four-part test to analyze the availability of the corresponding federal private offering exemption. See SEC v. Murphy, 626 F.2d 633, 644-45 (9th Cir. 1980); In re Offering of Securities by Lost Dutchman Invests., Inc., et al., Ariz. Corp. Comm’n Dec. No. 58259 (1993) (adopting and applying the federal court’s four-part test).

The flexible test adopted by federal courts to analyze the federal offering exemption focuses on the qualitative nature of the following four factors: (1) the number of offerees; (2) the sophistication of the offerees; (3) the size and manner of the offering; and (4) the relationship of the offerees to the issuer. Murphy, 626 F.2d at 644-645.

Regarding the first factor, there is no rigid limit on the number of offerees to whom an issuer can make an offering, but the fewer the offerees, the greater the likelihood that a court will consider the offering to be private instead of public. Murphy, 626 F.2d at 645.

A court is also more likely to consider an offering to be private if it involves more knowledgeable, sophisticated offerees―the people who are not in need of the protections afforded by the registration provisions of the Arizona Securities Act. Lost Dutchman Invests., Inc., Ariz. Corp. Comm’n Dec. No. 58259, at 20.

With regard to the third factor, a smaller offering made directly to the offerees rather than through the facilities of public distribution, is more likely to be considered a private offering. Murphy, 626 F.2d at 646.

Finally, if the offeror-offeree relationship is such that the offeree is privy to the disclosure of or access to the type of information typically provided through the registration process, a court is more likely to consider the offering to be private. Murphy, 626 F.2d at 647. Such relationships may include employment relationships, familial relationships, or some other type of relationship that bestows economic bargaining power upon the offeree that enables he or she to effectively gain access to the type of information that the registration statement would otherwise provide. A Guide to Arizona Securities Law, § 9.2.4 (citing Western Fed. Corp. v. Erickson, 739 F.2d 1439, 1442 (9th Cir. 1984)).

If, however, the requisite offeror-offeree relationship does not exist, the offeror must disclose the following 32 categories of information typically set forth in a registration statement, which include the use of investor funds, the benefits to be derived by issuer such as direct and indirect commissions, and accurate financial statements:

(1) name under which issuer is doing or intends to do business;

(2) name of State or other sovereign power under which issuer is organized;

(3) location of issuer’s principal business office, and if issuer is a foreign or territorial person, name and address of its agent in U.S. authorized to receive notice;

(4) names and addresses of directors or persons performing similar functions, and chief executive, financial and accounting officers, chosen or to be chosen if issuer be a corporation, association, trust, or other entity; of all partners, if issuer be a partnership; and of issuer, if issuer be an individual; and of promoters in case of a business to be formed, or formed within two years prior to filing registration statement;

(5) names and addresses of underwriters;

(6) names and addresses of all persons, if any, owning of record or beneficially, if known, more than 10 per centum of any class of stock of issuer, or more than 10 per centum in aggregate of outstanding stock of issuer as of a date within twenty days prior to filing registration statement;

(7) amount of securities of issuer held by any person specified in paragraphs (4), (5), and (6) of this schedule, as of a date within twenty days prior to filing registration statement, and, if possible as of one year prior thereto, and amount of securities, for which registration statement is filed, to which such persons have indicated their intention to subscribe;

(8) general character of business actually transacted or to be transacted by issuer;

(9) statement of capitalization of issuer, including authorized and outstanding amounts of capital stock and proportion thereof paid up, number and classes of shares in which such capital stock is divided, par value thereof, or if it has no par value, stated or assigned value thereof, description of respective voting rights, preferences, conversion and exchange rights, rights to dividends, profits, or capital of each class, with respect to each other class, including retirement and liquidation rights or values thereof;

(10) statement of securities, if any, covered by options outstanding or to be created in connection with security to be offered, together with names and addresses of all persons, if any, to be allotted more than 10 per centum in aggregate of such options;

(11) amount of capital stock of each class issued or included in shares of stock to be offered;

(12) amount of funded debt outstanding and to be created by security to be offered, with brief description of date, maturity, and character of such debt, rate of interest, character of amortization provisions, and security, if any, therefor. If substitution of any security is permissible, summarized statement of conditions under which such substitution is permitted. If substitution is permissible without notice, specific statement to that effect;

(13) specific purposes in detail and approximate amounts to be devoted to such purposes, so far as determinable, for which security to be offered is to supply funds, and if funds are to be raised in part from other sources, amounts thereof and sources thereof, shall be stated;

(14) remuneration, paid or estimated to be paid, by issuer or its predecessor, directly or indirectly, during past year and ensuing year to (a) directors or persons performing similar functions, and (b) officers and other persons, naming them wherever such remuneration exceeded $ 25,000 during any such year;

(15) estimated net proceeds to be derived from security to be offered;

(16) price at which it is proposed that security shall be offered to public or method by which such price is computed and any variation therefrom at which any portion of such security is proposed to be offered to any persons or classes of persons, other than underwriters, naming them or specifying class. A variation in price may be proposed prior to date of public offering of security, but Commission shall immediately be notified of such variation;

(17) all commissions or discounts paid or to be paid, directly or indirectly, by issuer to underwriters in respect of sale of security to be offered. Commissions shall include all cash, securities, contracts, or anything else of value, paid, to be set aside, disposed of, or understandings with or for benefit of any other persons in which any underwriter is interested, made, in connection with sale of such security. A commission paid or to be paid in connection with sale of such security by a person in which issuer has an interest or which is controlled or directed by, or under common control with, issuer shall be deemed to have been paid by issuer. Where any such commission is paid amount of such commission paid to each underwriter shall be stated;

(18) amount or estimated amounts, itemized in reasonable detail, of expenses, other than commissions specified in paragraph (17) of this schedule, incurred or borne by or for account of issuer in connection with sale of security to be offered or properly chargeable thereto, including legal, engineering, certification, authentication, and other charges;

(19) net proceeds derived from any security sold by issuer during two years preceding filing registration statement, price at which such security was offered to public, and names of principal underwriters of such security;

(20) any amount paid within two years preceding filing registration statement or intended to be paid to any promoter and consideration for any such payment;

(21) names and addresses of vendors and purchase price of any property, or good will, acquired or to be acquired, not in ordinary course of business, which is to be defrayed in whole or in part from proceeds of security to be offered, amount of any commission payable to any person in connection with such acquisition, and name(s) of such person(s), together with any expense incurred or to be incurred in connection with such acquisition, including cost of borrowing money to finance such acquisition;

(22) full particulars of nature and extent of interest, if any, of every director, principal executive officer, and of every stockholder holding more than 10 per centum of any class of stock or more than 10 per centum in aggregate of the stock of issuer, in any property acquired, not in ordinary course of business of issuer, within two years preceding filing registration statement or proposed to be acquired at such date;

(23) names and addresses of counsel who have passed on legality of issue;

(24) dates of and parties to, and general effect concisely stated of every material contract made, not in ordinary course of business, which contract is to be executed in whole or in part at or after filing registration statement or which contract has been made not more than two years before such filing. Any management contract or contract providing for special bonuses or profit-sharing arrangements, and every material patent or contract for material patent right, and every contract by or with public utility company or affiliate thereof, providing for giving or receiving of technical or financial advice or service (if such contract may involve a charge to any party thereto at a rate in excess of $ 2,500 per year in cash or securities or anything else of value), shall be deemed a material contract;

(25) balance sheet as of date not more than ninety days prior to date of filing registration statement showing all assets of issuer, nature and cost thereof, whenever determinable, in such detail and in such form as Commission shall prescribe (with intangible items segregated), including any loan in excess of $ 20,000 to any officer, director, stockholder or person directly or indirectly controlling or controlled by issuer, or person under direct or indirect common control with issuer. All liabilities of issuer in such detail and such form as Commission shall prescribe, including surplus of issuer showing how and from what sources such surplus was created, all as of date not more than ninety days prior to filing registration statement. If such statement be not certified by independent public or certified accountant, in addition to balance sheet required to be submitted under this schedule, a similar detailed balance sheet of assets and liabilities of issuer, certified by independent public or certified accountant, of date not more than one year prior to filing registration statement, shall be submitted;

(26) profit and loss statement of issuer showing earnings and income, nature and source thereof, and expenses and fixed charges in such detail and such form as Commission shall prescribe for latest fiscal year for which such statement is available and for two preceding fiscal years, year by year, or, if such issuer has been in actual business for less than three years, then for such time as issuer has been in actual business, year by year. If date of filing registration statement is more than six months after close of last fiscal year, statement from such closing date to latest practicable date. Such statement shall show what practice of issuer has been during three years or lesser period as to character of charges, dividends or other distributions made against its various surplus accounts, and as to depreciation, depletion, and maintenance charges, in such detail and form as Commission shall prescribe, and if stock dividends or avails from sale of rights have been credited to income, they shall be shown separately with statement of basis upon which credit is computed. Such statement shall also differentiate between any recurring and nonrecurring income and between any investment and operating income. Such statement shall be certified by independent public or certified accountant;

(27) if proceeds, or any part of proceeds, of security to be issued is to be applied directly or indirectly to purchase of any business, a profit and loss statement of such business certified by independent public or certified accountant, meeting requirements of paragraph (26) of this schedule, for three preceding fiscal years, together with balance sheet, similarly certified, of such business, meeting requirements of paragraph (25) of this schedule of a date not more than ninety days prior to filing registration statement or at date such business was acquired by issuer if business was acquired by issuer more than ninety days prior to filing registration statement;

(28) copy of any agreement or agreements (or, if identical agreements are used, forms thereof) made with any underwriter, including all contracts and agreements referred to in paragraph (17) of this schedule;

(29) copy of opinion(s) of counsel in respect to legality of issue, with a translation of such opinion, when necessary, into English language;

(30) copy of all material contracts referred to in paragraph (24) of this schedule, but no disclosure shall be required of any portion of such contract if Commission determines that disclosure of such portion would impair value of contract and would not be necessary for protection of investors;

(31) unless previously filed and registered under provisions of this title [15 USCS §§ 77a et seq.], and brought up to date, (a) copy of articles of incorporation, with all amendments thereof and of existing bylaws or instruments corresponding thereto, whatever name, if issuer be a corporation; (b) copy of all instruments by which trust is created or declared, if issuer is a trust; (c) a copy of its articles of partnership or association and all other papers pertaining to its organization, if issuer is a partnership, unincorporated association, joint stock company, or any other form of organization; and

(32) copy of underlying agreements or indentures affecting any stock, bonds, or debentures offered or to be offered.

15 U.S.C. § 77aa, Schedule A; Murphy, 626 F.2d at 647.

These four foregoing factors help to determine whether the sort of accurate, material information about the issuer that the public registration statement typically reveals is available to and understood by each offeree. The information is “available” if it is disclosed to the offeree or the offeree has effective access to it because he or she occupies a privileged position relative to the issuer that affords the offeree an opportunity for effective access to the information. A Guide to Arizona Securities Law, § 9.2 (citing Western Fed. Corp., 739 F.2d at 1443). In such circumstances, the offeree does not need the protection of securities laws and therefore the issuer and its offering are exempt from the securities registration requirements. Id. See also SEC v. Ralston Purina Co., 346 U.S. 119, 125 (1953) (“offering to those who are shown to be able to fend for themselves is a transaction not involving any public offering”).

The statutory private offering exemption is self-executing, and therefore an issuer does need to file any paperwork or submit a filing fee to utilize the exemption. A Guide to Arizona Securities Law, § 9.2.7.

Accordingly, private offerings are those that are small and made directly to a small number of sophisticated offerees who have a pre-existing relationship with the offeror.

The majority of successful private offerings consist of “’private placements’ of large blocks of securities with institutional investors—typically the sale of notes or debentures to one or more insurance companies or pension funds,” or “offerings to key employees of the issuing company and in exchange offers to acquire the stock of closely-held companies.” Hazen and Ratner, Securities Regulation in a Nutshell 65 (9th ed. 2006).

II. Private Offering Exemption under A.A.C. § 14-4-126.

A.A.C. § 14-4-126 (“Rule 126”) also “relates to transactions exempted from the registration requirements of A.R.S. §§ 44-1841 and 44-1842.” A.A.C. § 14-4-126(A). Rule 126 is the counterpart to federal Regulation D (17 C.F.R. § 230.500-506).

Attempted compliance with any part of Rule 126 is not act as an exclusive election. Id. § 14-4-126(A)(1). However, Rule 126 is not available to any issuer for any transaction(s) that, although in technical compliance with Rule 126, is part of a plan or scheme to evade the registration provisions of the Arizona Securities Act. Id.

A. Definitions and Terms under A.A.C. § 14-4-126(B).

Rule 126(B) sets forth its applicable definitions and terms, including accredited investor, affiliate, aggregate offering price, business combination, calculation of number of purchasers, executive officer, issuer, and purchaser representative. Id. § 14-4-126(B).

An “accredited investor” is “any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person: (1) bank, savings and loan association, registered broker or dealer, insurance company, investment company, business development company, small business investment company, state employee benefit plan with total assets in excess of $5 million, or employee benefit plan; (2) private business development company; (3) charitable organization or educational institution with total assets in excess of $5 million; (4) director, executive officer or general partner of the issuer or of that general partner; (5) person whose individual net worth, or joint net worth with that person’s spouse, at the time of purchase exceeds $1 million; (6) person with an annual individual income of more than $200,000 for the past two years (or, together with that person’s spouse, an annual joint income of more than $300,000) and has a reasonable expectation of reaching the same income level in the current year; (7) trust with more than $5 million in assets which is managed by a sophisticated person and not formed for the specific purpose of acquiring the securities offered; and (8) entity in which all of the equity owners are accredited investors. Id. § 14-4-126(B)(1).

An “affiliate” is a “person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the person specified.” Id. § 14-4-126(B)(2).

The “aggregate offering price” is “the sum of all cash, services, property, notes, cancellation of debt, or other consideration to be received by an issuer for issuance of its securities.” Id. § 14-4126(B)(3). “Where securities are being offered for both cash and non-cash consideration, the aggregate offering price shall be based on the price at which the securities are offered for cash.” Id. “If securities are not offered for cash, the aggregate offering price is based on the value of the consideration as established by bona fide sales of that consideration made within a reasonable time, or, in the absence of sales, on the fair value as determined by generally accepted accounting principles,” which must be reasonable at the time made. Id.

The “calculation of number of purchasers,” for purposes of Rules 126(E) and 126(F), includes as purchasers the clients of an investment adviser or customers of a broker or dealer, regardless of the amount of discretion given to the investment advisor or broker or dealer to act on behalf of the client or customer. Id. § 14-4-126(B)(5). The following purchasers are excluded: (1) any relative, spouse, or relative of the spouse of a purchaser who has the same principal residence as the purchaser; (2) any trust or estate in which a purchaser and any of the persons related to the purchaser as specified in Rule 126(B)(5)(a)(i) or (iii) collectively have more than 50% of the beneficial interest (excluding contingent interests); (3) any corporation or other organization of which a purchaser and any of the persons related to the purchaser as specified in Rule 126(B)(5)(a)(i) or (ii) collectively are beneficial owners of more than 50% of the equity securities (excluding directors’ qualifying shares) or equity interests; and (4) any accredited investor. Id. § 14-4-126(B)(5)(a). However, the issuer must satisfy all other provisions of Rule 126 for all purchasers whether or not they are included in calculating the number of purchasers. Id. Finally, the following are only one purchaser: (1) a corporation, partnership or entity, unless that entity is organized for the specific purpose of acquiring the securities offered and is not an accredited investor, and then each beneficial owner of equity securities or interests counts as a separate purchaser for all provisions of Rule 126 except as provided in Rule 126(B)(5)(a); and (2) a noncontributory employee benefit plan where the trustee makes all investment decisions for the plan. Id. § 14-4-126(B)(5)(b)-(c).

An “executive officer” is “the president, any vice president in charge of a principal business unit, division, or function (such as sales, administration, or finance), any other officer who performs a policy-making function, or any other person who performs similar policy-making functions for the issuer.” Id. § 14-4-126(B)(6). Moreover, “[e]xecutive officers of subsidiaries may be deemed executive officers of the issuer if they perform such policy-making functions for the issuer.” Id.

An “issuer” is “any person who issues or proposes to issue any security, except:”

(a) With respect to certificates of deposit, voting-trust certificates, collateral-trust certificates, certificates of interest or shares in an unincorporated investment trust, whether or not of the fixed, restricted management, or unit type, issuer means the person or persons performing the acts and assuming the duties of depositor or manager pursuant to the provisions of the trust or other agreement or instrument under which such securities are issued;

(b) With respect to equipment-trust certificates or like securities, issuer means the person by whom the equipment or property is or is to be used;

(c) With respect to fractional interests in any oil, gas or other mineral lease, permit, claim or right, issuer means the owner thereof or of any interest therein, whether whole or fractional, fractional interests in which are created for the purpose of a public offering.

Id. § 14-4-126(B)(7); A.R.S. § 44-1801(13).

A “purchaser representative” is “any person who satisfies the following conditions or who the issuer reasonably believes satisfies all of the following conditions:”

(1) is not an affiliate, director, officer, or other employee of the issuer, or beneficial owner of 10% or more of any class of the equity securities or 10% or more of the equity interest in the issuer, except where the purchaser is (i) a relative of the purchaser representative by blood, marriage, or adoption and not more remote than a first cousin; (ii) a trust or estate in which the purchaser representative and any persons related to the purchaser representative as specified in Rule 126(B)(8)(a)(i) or (iii) collectively have more than 50% of the beneficial interest (excluding contingent interests) or which the purchaser representative serves as trustee, executor, or in any similar capacity; or (iii) a corporation or other organization of which the purchaser representative and any persons related to the purchaser representative as specified in Rule 126(B)(8)(a)(i) or (ii) collectively are beneficial owners of more than 50% of the equity securities (excluding directors’ qualifying shares) or equity interests;

(2) has such knowledge and experience in financial and business matters that the purchaser representative is capable of evaluating, alone or together with other purchaser representatives of the purchaser or together with the purchaser, the merits and risk of the prospective investment;

(3) is acknowledged by the purchaser in writing, during the course of the transaction, to be the purchaser’s purchaser representative in connection with evaluating the merits and risks of the prospective investment; and

(4) discloses to the purchaser in writing a reasonable time prior to the sale of securities to that purchaser any material relationship between the purchaser representative or the purchaser representative’s affiliates and the issuer or its affiliates that then exist, that is mutually understood to be contemplated, or that has existed at any time during the previous two years, and any compensation received or to be received as a result of such relationship.

§ 14-4-126(B)(8)(a)-(d). A person acting as a purchaser representative must consider the applicability of the registration and anti-fraud provisions: (1) relating to dealers under the Arizona Securities Act; and (2) relating to investment advisers under the Arizona Investment Management Act. Id. § 14-4-126(B)(8)(e). The acknowledgment required by 126(B)(8)(c) and the disclosure required by 126(B)(8)(d) must be made with specific reference to each prospective investment; advance blanket acknowledgment, such as for “all securities transactions” or “all private placements,” is not sufficient. Id. § 14-4-126(B)(8)(f). Finally, disclosure of any material relationships between the purchaser representative or the purchaser representative’s affiliates and the issuer or its affiliates does not relieve the purchaser representative of the obligation to act in the interest of the purchaser. Id. § 14-4-126(B)(8)(g).

B. General Conditions under A.A.C. § 14-4-126(C): Integration, Information Requirements, and Prohibition of General Advertising and General Solicitation and Resale.

1. Integration.

All sales that are part of the same Rule 126 offering must meet all of the terms and conditions of Rule 126(C)(1). Rule 126(C)(1) provides for integration as follows: offers and sales that are made more than six months before the start of a Rule 126 offering or are made more than six months after completion of a Rule 126 offering are not considered part of the Rule 126 offering, so long as during those six-month periods there are no offers or sales of securities by or for the issuer that are of the same or a similar class as those offered or sold under Rule 126, other than those offers or sales of securities under any written purchase, savings, option, bonus, appreciation, profit sharing, thrift, incentive, pension, or similar plan, or written compensation contract, solely for employees, directors, general partners, trustees (where the issuer is a business trust), officers, or consultants or advisors, provided that bona fide services must be rendered by consultants or advisors, and such services must not be in connection with the offer or sale of securities in a capital-raising transaction. Id. § 14-4-126(A)(1). If the issuer offers or sells securities for which the safe harbor rule in Rule 126(C)(1) is unavailable, and since the term “offering” is not defined, the determination as to whether separate sales of securities are part of the same offering (i.e., are “integrated”) depends on the particular facts and circumstances. Id. § 126(C)(1)(a).

The following factors should be considered in determining whether offers and sales should be integrated or purposes of a private offering exemption: (1) whether the sales are part of a single plan of financing; (2) whether the sales involve issuance of the same class of securities; (3) whether the sales have been made at or about the same time; (4) whether the same type of consideration is received; and (5) whether the sales are made for the same general purpose. Id. § 14-4-126(C)(1)(c).

2. Information Requirements.

Rule 126(C)(2) sets for the information requirements. If the issuer sells securities to any purchaser that is not an accredited investor, the issuer must furnish the information specified in Rule 126(C)(2) to such purchaser within a reasonable time prior to the sale. Id. § 14-4-126(C)(2)(a). The issuer is not required to furnish the specified information to any accredited investor. Id.

If the issuer is not subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”), at a reasonable time prior to the sale of securities, the issuer must furnish to the purchaser, to the extent material to an understanding of the issuer, its business, and the securities being offered: (1) if the issuer is eligible to use Regulation A, the same kind of information as would be required in Part II of Form 1-A; if the issuer is not eligible to use Regulation A, the same kind of information as required in Part I of a registration statement filed under the Securities Act of 1933 (“Securities Act”) on the form that the issuer would be entitled to use; (2) for offerings up to $2 million, the financial statement information required in Item 310 of Regulation S-B, except that only the issuer’s balance sheet, which must be dated within 120 calendar days of the start of the offering, must be audited; (3) for offerings up to $7.5 million, the financial statement information required in Form SB-2; and (4) for offerings over $7.5 million, the financial statement information as would be required in a registration statement filed under the Securities Act on the form that the issuer would be entitled to use.

With respect to Rule 126(C)(2)(b)(iii) and (iv), if an issuer other than a limited partnership, cannot obtain audited financial statements without unreasonable effort or expense, the only the issuer’s balance sheet, which must be dated within 120 calendar days of the start of the offering, must be audited; if the issuer is a limited partnership and cannot obtain the requirement financial statements without unreasonable effort or expense, it may furnish financial statements that have been prepared on the basis of federal income tax requirements and examined and reported on in accordance with generally accepted auditing standards by an independent public or certified accountant. Id. § 14-4-126(C)(2)(b)(iii) and (iv).

If the issuer is subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act, at a reasonable time prior to the sale of securities, the issuer must furnish to the purchaser the information specified in Rule 126(C)(2)(c)(i) or (ii), and in either event the information specified in Rule 126(C)(2)(c)(iii): (1) the issuer’s annual report to shareholders for the most recent fiscal year, the definitive proxy statement filed in connection with the annual report, and if requested by the purchaser in writing, a copy of the issuer’s most recent Form10-K and Form 10-KSB under the Exchange Act; (2) the information contained in an annual report on Form 10-K or Form 10-KSB under the Exchange Act, in a registration statement on Form S-1, SB-1 SB-2 or S-11 under the Securities Act, or on Form 10 or Form 10-SB under the Exchange Act, whichever is most recently required to be filed; and (3) the information contained in any reports or documents required to be filed by the issuer under Sections 13(a), 14(a), 14(c), and 15(d) of the Exchange Act since the distribution or filing of the report or registration statement specified in Rule 126(C)(2)(c)(i) or (ii), and a brief description of the securities being offered, the use of the proceeds from the offering, and any material changes in the issuer’s affairs that are not disclosed in the documents furnished. Id. § 14-4-126(C)(2)(c).

Exhibits required to be filed with the SEC as part of a registration statement or report, other than an annual report to shareholders or parts of that report incorporated by reference in a Form 10-K and Form 10-KSB report, need not be furnished to each purchaser that is not an accredited investor if the contents of material exhibits are identified and such exhibits are made available to a purchaser, upon the purchaser’s written request, within a reasonable time prior to the purchase. Id. § 14-4-126(C)(2)(d).

At a reasonable time prior to the sale of securities to any purchaser that is not an accredited investor in a transaction under Rule 126(E) or (F), the issuer must furnish to the purchaser a brief written description of any material written information concerning the offering that has been provided by the issuer to any accredited investor but not previously delivered to such non-accredited purchaser. Id. § 14-4-126(C)(2)(e). The issuer must furnish any portion or all of this information to the purchaser, upon the purchaser’s written request, within a reasonable time prior to the purchase. Id.

The issue must also make available to each purchaser at a reasonable time prior to the purchaser’s purchase of securities in a transaction under Rule 126(E) or (F), the opportunity to ask questions and receive answers concerning the terms and conditions of the offering and to obtain any additional information which the issuer possesses or can acquire without unreasonable effort or expense that is necessary to verify the accuracy of information furnished under Rule 126(C)(2)(b) or (c). Id. § 14-4-126(C)(2)(f).

3. General Solicitation and General Advertising Prohibited.

Rule 126(C)(3) limits the manner of the offering by prohibiting any general solicitation or general advertising as follows: neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising, including but not limited to, the following: (1) any advertisement, article, notice, or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and (2) any seminar or meeting whose attendees have been invited by any general solicitation or general advertising. Id. § 14-4-126(C)(3). Aside from these examples, general advertising and general solicitation are not defined terms.

Based upon the federal counterpart to Rule 126, Regulation D Rule 506, and the SEC’s interpretations thereof, whether a particular action constitutes general advertising or general solicitation depends upon the specific facts and circumstances of an offering. See Interpretive Release on Regulation D, Securities Act Release No. 33-6455.

i. General Advertisements.

General advertisements for the securities are prohibited, but advertisements for goods and services other than securities may be permitted, depending upon the content of the advertisements and actual use of the advertisements in relation to the securities offering. Rogers, Scharman and Jacobsen, Avoiding General Solicitations in a Securities Private Placement, Utah Bar Journal, March 2010.

If the primary purpose of an advertisement is to sell the securities and condition the market for future sales, the advertisement may constitute an offer, even if the issuer is not currently offering the securities, and be prohibited under Rule 126(C)(3). Id.

The same is true of general advertisements for information seminars: if the purpose of the seminar is to attract new investors to an offering, versus providing generic industry information, it is likely prohibited as a general advertisement by Rule 126(C)(3). Id.

In short, the purpose of an advertisement, not necessarily its content, is the relevant factor is deciding whether it is a general advertisement prohibited under Rule 126(C)(3).

ii. General Solicitations.

In determining whether a general solicitation has occurred, the SEC focuses on the relationship between an issuer and a potential investor. Id.

For a communication not to qualify as a general solicitation, there must be a pre-existing and substantive business relationship between the issuer and the potential investor. See, e.g., Bateman Eichler, Hill Richards, Inc., 1985 SEC No-Action Letter LEXIS 2918 (Dec. 3, 1985); E.F. Hutton & Co., 1985 SEC No-Action Letter LEXIS 2917 (Dec. 3, 1985); Woodtrails-Seattle, Ltd., 1982 SEC No-Action Letter LEXIS 2662 (Aug. 9, 1982).

For a pre-existing relationship between the issuer and potential investor, the relationship must have existed for a period of time prior to the current private offering. See E.F. Hutton & Co., 1985 SEC No-Action Letter. A pre-existing relationship most likely exists with the following: (1) potential investors that the issuer has a business relationship with that allows the issuer to be reasonably sure that the potential investor is sufficiently sophisticated in financial matters to participate in the offering; or (2) potential investors who have participated in previous offerings with the issuer. Rogers, Scharman and Jacobsen, "Avoiding General Solicitations in a Securities Private Placement," Utah Bar Journal, March 2010; Woodtrails-Seattle, Ltd., 1982 SEC No-Action Letter.

For a substantive relationship between the issuer and potential investor, the relationship must be such that the issuer is fully aware of the financial circumstances or sophistication of the investor, and his or her ability to evaluate the benefits and risks of the proposed offering. See Rogers, Scharman and Jacobsen, "Avoiding General Solicitations in a Securities Private Placement," Utah Bar Journal, March 2010. Such substantive relationships would include those involving accredited investors, as accredited investors are presumed to be sophisticated. See 17 C.F.R. § 230.501(a); H.B. Shaine & Co., Inc., 1987 SEC No-Action Letter LEXIS 2004 (May 1, 1987).

The SEC has offered guidance on how a broker-dealer can create a pre-existing and substantial relationship with a potential investor through a questionnaire, that may apply to an issuer as well. See Rogers, Scharman and Jacobsen, Avoiding General Solicitations in a Securities Private Placement, Utah Bar Journal, March 2010.

A broker-dealer can establish a substantive relationship with a potential investor by using a generic suitability questionnaire that provides sufficiently detailed information to evaluate the potential investor’s financial circumstances and sophistication. See H.B. Shaine & Co., Inc., 1987 SEC No-Action Letter; Mineral Lands Research & Mktg. Inc., 1985 SEC No-Action Letter LEXIS 2811 (Dec. 4, 1985); Bateman Eichler, Hill Richards, Inc., 1985 SEC No-Action Letter. Once that substantive relationship exists, the broker-dealer can place offering materials on a password-protected website. See IPONET, 1996 SEC No-Action Letter LEXIS 642 (July 26, 1996).

A broker-dealer can then establish a pre-existing relationship by allowing for a sufficient waiting period or cooling-off period between the time of the suitability questionnaire and the initial private offering. See H.B. Shaine & Co., Inc., 1987 SEC No-Action Letter; E.F. Hutton & Co., 1985 SEC No-Action Letter. A waiting period of at least 30 to 45 days after the relationship has first been established before an offer is sufficient to constitute a pre-existing relationship. See, e.g., Lamp Techs, Inc., 1997 SEC No-Action Letter LEXIS 638 (May 29, 1997) (30-day waiting period between day potential investor qualified for website listing hedge fund information that only accredited investors could access and day investor could invest in fund listed on website sufficient, and investor could then invest in any posted offering); Bateman Eichler, Hill Richards, Inc., 1985 SEC No-Action Letter (45-day waiting period between day of initial contact with potential investor and day of offering sufficient, provided no securities offering at time of initial contact); E.F. Hutton & Co., 1985 SEC No-Action Letter (45 days). However, seven days is not a sufficient waiting period. See SEC v. Credit First Fund, LP, 2006 U.S. Dist. LEXIS 96697 (C.D. Cal. 2006) (one-week waiting period between initial cold call and follow up call with offering insufficient to establish pre-existing relationship).

Again, the SEC approved the procedures for creating a substantive and pre-existing relationship with a detailed suitability questionnaire and 30-45 day waiting period thereafter for licensed broker-dealers, and not necessarily issuers. So far, the SEC has declined to give a no-action letter to an issuer contemplating building a database of accredited investors by sending a generic financial questionnaire to users of it services that the issuer believed were likely accredited investors. See Agristar Global Networks, Ltd., 2004 SEC No-Action Letter LEXIS 203 (Feb. 9, 2004). This may be because in a broker-dealer relationship, the broker-dealers must deal fairly with, and make suitable recommendations to, its customers, thereby implying that a substantive relationship already exists between the broker-dealer and its customers, unlike an issuer. See Securities Act Release No. 33-7856 (April 28, 2000), 2000 SEC LEXIS 847.

4. Resale Prohibited.

At a reasonable time prior to the sale of securities to any purchaser that is not an accredited investor in a transaction under Rule 126(E) or (F), the issuer must advise the purchaser of the limitations on resale in the manner contained in Rule 126(C)(4)(b). Id. § 14-4-126(C)(2)(h). Such disclosure may be contained in other materials required to be provided by Rule 126(C)(2). Id. Rule 126(C)(4) limits resale of the securities as follows: securities acquired in a transaction under Rule 126 have the status of securities acquired in an exempt transaction under A.R.S. § 44-1844 and cannot be resold without registration under the Arizona Securities Act or an exemption therefrom. Id. § 14-4-126(C)(4). The issuer must exercise reasonable care to assure that the purchasers of securities are not underwriters, and the issuer may demonstrate such reasonable care by the following: (1) reasonable inquiry to determine if the purchaser is acquiring the securities for the purchaser or for other persons; (2) written disclosure to each purchaser prior to sale that the securities have not been registered under the Arizona Securities act, and therefore cannot be resold unless they are registered under the Arizona Securities Act or an exemption from registration is available; and (3) placement of a legend on the certificate or other document that evidences the securities stating that the securities have not been registered under the Arizona securities Act and setting forth or referring to the restrictions on transferability and sale of the securities. Id. While taking the foregoing actions will establish the requisite reasonable care, it is not the exclusive method to demonstrate such care; other actions taken by the issuer may satisfaction this provision. Id. Further, Rule 126(C)(2)(h) requires the delivery of written disclosure of the limitations on resale to investors in certain circumstances. Id.

C. Filing Requirements under A.A.C. § 14-4-126(D): Form D, $250.00 Initial Filing Fee and $100.00 Final Filing Fee.

The issuer must file with the Commission one copy of a notice on Form D at the following times: (1) no later than 15 calendar days after the first sale of securities in or from Arizona in an offering under Rule 126; and (2) no later than 30 calendar days after the termination of an offering under Rule 126; provided however, that noncompliance with Rule 126(D)(1)(b) does not result in the loss of the exemption under Rule 126, if the issuer has complied with the filing requirements of Rule 126(D)1)(a). Id. § 14-4-126(D)(1). If the Arizona Securities Division sends a written request to an issuer to file a final Form D, the issuer must deliver a final Form D to the Arizona Securities Division within 30 calendar days of receipt of such request. Id.

No exemption under Rule 126 is available for an issuer if such issuer or any of its predecessors or affiliates have been subject to any order, judgment, or decree of the Commission or any other court of competent jurisdiction temporarily, preliminarily, or permanently enjoining such person for failure to comply with the filing requirements of Rule 126(D); provided, however, that the loss of the exemption does not apply if the Commission determines upon a showing of good cause that it is not necessary under the circumstances that the exemption be denied. Id.

If the offering is completed within the 15-day period described in Rule 126(D)(1)(a) and if the notice is filed no later than the end of that period but after completion of the offering, then only one notice need be filed to comply with Rule 126(D)(1)(a) and (b). Id. § 14-4-126(D)(2).

The notice on form D must contain a manual or facsimile signature of a person duly authorized by the issuer. Id. § 14-4-126(D)(3).

If sales are made under Rule 126(E), the notice must contain an undertaking by the issuer to furnish the Commission, upon the written request of staff, the information furnished by the issuer under Rule 126(C)(2) to any purchaser that is not an accredited investor. Id. § 14-4-126(D)(4).

If more than one notice for an offering is required to be filed under Rule 126(D)(1), notices after the first notice need only report the issuer’s name and the information required by Part C and any material change in the facts from those set forth in Parts A and B of the first notice. Id. § 14-4-126(D)(5).

A notice on Form D is considered filed with the Commission: (1) upon receipt at its Phoenix office; (2) as of the date on which the notice is mailed by means of U.S. registered or certified mail to the Commission’s Phoenix office if the notice is delivered to such office after the date on which it is required to be filed. Id. § 14-4-126(D)(6).

Finally, the issuer must pay an initial filing fee of $250.00 and, if applicable, a final filing fee of $100.00. Id. § 14-4-126(D)(7); A.R.S. § 44-1861(E).

D. Limited Offering Exemption under A.A.C. § 14-4-126(E): Unlimited Number of Accredited Investors, Up to 35 Non-Accredited Investors, and $5 Million in 12 Months.

Offers to sell or sales of securities that are part of an offering that complies with all of the general conditions listed in Rule 124(B)-(D) (discussed above) and specific conditions in (E)(2) (discussed below), by an issuer that is not an investment company, are exempt transactions under A.R.S. §44-1844 and thus exempt from the registration requirements in A.R.S. §§ 44-1841 and 44-1842. Id. § 14-4-126(E)(1)-(2)(a).

The specific conditions for Rule 126(E), are that: (1) the aggregate offering price does not exceed $5 million, less the aggregate offering price for all securities sold within the 12 months before the start of and during such offering of securities in reliance on Rule 126(E) or in violation of A.R.S. § 44-1841; and (2) there are no more than, or the issuer reasonably believes there are than, 35 purchasers of securities from the issuer in any offering under Rule 126(E). Id. § 14-4-126(E)(2)(b)-(c). In other words, for a limited offering, the aggregate offering price cannot exceed $5 million in 12 months, and there can be an unlimited numbers of accredited investors, but only 35 other purchasers. Id.

No exemption is available under Rule 126(E) for the securities of any issuer if the issuer or any of its predecessors, affiliates, directors, officers, general partners, or beneficial owners of 10% or more of any class of its equity securities, or the underwriter of such securities: (1) has been convicted within the 10 years preceding the filing of the notice required by Rule 126, or at any time thereafter prior to the termination of the offering, of a felony or misdemeanor involving racketeering or a transaction in securities, or of which fraud is an essential element; (2) is subject to an order, judgment, or decree of a court of competent jurisdiction entered within five years of the date of filing from engaging in or continuing any conduct or practice in connection with the sale or purchase of securities, or involving fraud, deceit, or racketeering; (3) has been subject to any state or federal administrative order or judgment in connection with the purchase or sale of securities entered within five years preceding the filing of the notice required by Rule 126, or at any time thereafter prior to the termination of the offering; (4) is subject to the reporting requirements of the Exchange Act and not filed all required reports during the 12 calendar months preceding the filing of the notification required by Rule 126(D)(1); or (5) is subject to an order of the SEC denying or revoking registration as a broker or dealer in securities under the Exchange Act, is subject to an order denying or revoking membership in a national securities association registered under the Exchange Act, or has been suspended for a prior exceeding six months or expelled from membership in a national securities exchanged registered under the Exchange Act. Id. § 14-4-126(E)(3)(a)-(e). The Commission has the discretion to waive any disqualification. Id. § 14-4-126(E)(3)(f). Further, a disqualification caused by Rule 126(E)(3) ceases to exist if: (1) the basis for the disqualification has been removed by the jurisdiction creating it; (2) the jurisdiction in which the disqualifying event occurred issues a written waiver of the disqualification; or (3) the jurisdiction in which the disqualifying event occurred declines in writing to enforce the disqualification. Id.

E. Private Offering Exemption under A.A.C. § 14-4-126(F): Unlimited Offering, Unlimited Number of Accredited Investors and Up to 35 Non-Accredited, Sophisticated Investors.

Rule 126(F) is the safe harbor for private offerings under A.R.S. § 44-1844(A)(1). Instead of relying on the above state and federal case law interpreting A.R.S. § 44-1844(A)(1) and 15 U.S.C. § 77d(2), issuers may rely on Rule 126(F) to qualify for the private offering exemption. Id. § 14-4-1126(F)(1). Offers to sell or sales of securities that are part of an offering that complies with all of the general conditions listed in Rule 124(B)-(D) (discussed above) and specific conditions in (F) (discussed below) are automatically considered private offerings within the meaning of A.R.S. § 44-1844(A)(1), and are therefore exempt from the registration requirements in A.R.S. §§ 44-1841 and 44-1842. Id.

The specific conditions for Rule 126(F), for which there is no dollar limitation, are that: (1) there are no more than, or the issuer reasonably believes there are no more than, 35 purchasers of securities from the issuer in any offering under Rule 126(F); and (2) each purchaser who is not an accredited investor either alone or with a purchaser’s purchaser representative(s) has such knowledge and experiences in financial and business matters that the purchaser is capable of evaluating the merits and risks of the prospective investment, or the issuer reasonably believes immediately prior to making any sales that such purchaser comes within this description. Id. § 14-4-126(F)(2). In other words, there is an unlimited aggregate offering price and there can be an unlimited number of accredited investors but only 35 other sophisticated purchasers. Id.

F. Disqualifying Events under A.A.C. § 14-4-126(G).

The exemptions under Rules 126(E) and 126(F) are not available to an issuer if the issuer, or any of its predecessors or affiliates have been subject to any order, judgment, or decree of any court of competent jurisdiction, temporarily, preliminary or permanently enjoining such person, or any final order of an administrative agency direction such person to cease-and-desist for failure to comply with subsection (D) or its counterpart, if any, in such jurisdiction. Id. § 14-4-126(G)(1).

The Commission has the discretion to waive any disqualification. Id. § 14-4-126(G)(2).

Further, a disqualification ceases to exist if: (1) the basis for the disqualification has been removed by the jurisdiction creating it; (2) the jurisdiction in which the disqualifying event occurred issues a written waiver of the disqualification; or (3) the jurisdiction in which the disqualifying event occurred declines in writing to enforce the disqualification. Id. § 14-4-126(G)(3).

G. Insignificant Deviations under A.A.C. § 14-4-126(H).

The failure to comply with a term, condition, or requirement of Rule 126(E) or Rule 126(F) will not result in the loss of the exemption from the registration requirements of A.R.S. §§ 44-1841 and 44-1842 for any offer or sale to a particular individual or entity, if the person relying on the exemption shows all three of the following: (1) the failure to comply did not pertain to a term, condition, or requirement directly intended to protect that particular individual or entity; (2) the failure to comply was insignificant with respect to the offering as a whole (with subsections (C)(3), (E)(2)(b), (E)(2)(c), and (F)(2)(a) being significant to the offering as a whole); and (3) a good faith and reasonable attempt was made to comply with all applicable terms, conditions, and requirements of subsections (E) and (F). Id. § 14-4-126(H)(1).

Notwithstanding Rule 126(H)(1) on insignificant deviations, an exemption established only through reliance upon Rule 126(H)(1) is a violation of Rule 126, and the Commission may take action under A.R.S. §§ 44-2032 and 44-2036, which can result in cease and desist orders, civil penalties, injunctions, civil restitution, prosecution, and administrative penalties. Id. § 14-4-126(H)(2).
If you have questions regarding a possible securities law matter, or to arrange for a consultation concerning your legal matter, please contact Robert Mitchell at rdm@tblaw.com or at (602) 452-2730.
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