In what strikes many people (especially from other countries) as odd, frequently both federal law and state laws apply to a securities offering. Often those laws are different and both must be satisfied for a legal offering.
One exception is federal Rule 506, which preempts state securities law. The states are allowed to require Rule 506 offerors to make a brief “notice” filing when the offer has investors from that state — but the states cannot apply their own securities laws. This, though, is a rare situation: Most federal offering exemptions (for example, Rules 504 and 505) do not preempt state law.
The other main exception is when an offering is confined to a single state in what is called an “intrastate offering”. (This is not to be confused with “interstate”, as in “interstate commerce”, which means crossing state lines. It’s like the difference between the Internet, which connects multiple networks, and an intranet, which is a single network.)
For the intrastate exemption “safe harbor” from federal regulation to apply a) all investors be residents of one state, b) the offering company must be an entity formed in that state, c) the entity must have its principal place of business in that state, and d) the entity must have and expect it will have 80% of its assets, sources of revenue and expenditures of the amounts raised in that state.
Outside of that is a gray area. The basic intrastate exemption statute says that the issuing company must be doing business within the state. In turn, that has been interpreted in one court case as meaning that the issuing company must conduct a “predominant” amount of “income-producing operations” within that state. What “predominant” means and how widely this opinion applies is uncertain, though, so there is some risk in taking this approach rather than using the safe harbor or also complying with federal securities law.
Another approach that can often be used when the safe-harbor requirements cannot be met is to use Rule 505 to satisfy the federal securities requirements. This requires that Form D be filed with the SEC (and the requirements of Rule 505 be met) but that can be a better option than relying on the “predominant” test.
Bruce E. Methven
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