SEC Investment Offerings Securities Restrictions Relaxed
Those wishing to raise money for real estate investments will now be able to advertise their offerings to the general public without registering a securities offering either with the Securities and Exchange Commission (the “SEC”) or with any state securities regulatory agency. It is difficult to overstate the importance of this change for small real estate developers and syndication companies, including those offering tenancy in common (“TIC”) interests as (Internal Revenue Code Section) 1031 tax-deferred exchange opportunities. Previously, the vast majority of real estate investment opportunities, including 1031 TIC investments, had to be offered privately regardless of the number of investors involved. The new law will dramatically ease the regulatory burden for these investment offerings, make it much easier to find investors and raise investment capital, and lower the risk for organizers, sponsors and brokers.
Each time a real estate investment is offered, the seller, broker, and any other professional involved in the offering, needs to ask him/herself whether the offering is regulated by securities law. Contrary to what many real estate professionals believe, securities regulations often apply even if the purchaser receives a deed. A similarly common misconception is that a sale to fewer than 35 people is never regulated as a securities offering. In fact, even a single piece of investment property, deeded to two people, can be a regulated securities offering if the circumstances bring it within the relevant legal definitions under federal or state law. The key question is whether the investor will be relying on someone else’s efforts to make a profit.
If a real estate investment offering is covered by securities regulations, the difficulty and cost of complying with securities regulations historically depended on whether it was going to be advertised. This is because Federal securities law exempts certain “private” offerings from the expensive and time-consuming securities registration and approval requirements imposed by the SEC and most states. The catch was that the offering could only be promoted privately; marketing the investment to the general public was prohibited.
The first step in easing these securities regulations was the enactment of the “The Jumpstart Our Business Startups Act (the “JOBS Act”) on April 5, 2012. The JOBS Act required the SEC to revise securities regulations to allow advertising of investment offerings provided that all of the investors are “accredited”.
The New SEC Regulations
SEC has now amended Rule 506 of Regulation D, which is one of a group of SEC Rules exempting private-placement securities offerings from registration requirements. A Rule 506 private-placement securities offering can include an unlimited number of “Accredited Investors” and up to 35 investors who are not “Accredited”. There are a variety of ways that in investor may qualify as “Accredited”, but the most common way is by satisfying thresholds of net worth (currently $1,000,000 excluding primary residence) or annual income (currently $200,000 individual, or $300,000 with spouse, in each of the two most recent years, with a reasonable expectation of continuity). A Rule 506 private-placement securities offering also requires that the sponsor file an informational form with the SEC, and that investors receive a Private Placement Memorandum (“PPM”), a detailed business plan with a series of important disclosures, disclaimers and warnings.
Following the JOBS Act, SEC adopted a new Rule 506(c) under which a private-placement investment offering could be marketed, and investors solicited, through general advertising and marketing. To qualify to advertise and offering under Rule 506(c), the investment group must be limited to Accredited Investors, and the project sponsor must reasonable steps to verify that each investor satisfies the accreditation requirements. SEC has suggested a variety of methods of verification depending on the basis through which the investor claims to be “Accredited”. Other current requirements for a Rule 506 private-placement offering, including preparing a PPM and filing a form with SEC, would continue to be required.
About the Author
Since 1984, Andy Sirkin’s law practice has focussed on developing and documenting creative and practical approaches to real estate investing. He is known for his ability to help his clients evolve general concepts and business model ideas into fully developed and detailed business plans by quickly identifying hidden issues and solving seemingly complex problems. He favors reasonable and cost-effective solutions to regulatory challenges, and simple, short, plain-English legal documents. In addition to over 30 years of legal practice experience in the US and overseas, including work with numerous web-based and non-technology startups, he brings extensive experience as a real estate builder/developer, syndicator, brokerage manager, income-property owner, and passive investor.