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Why The SEC's Pre-Existing Relationship Test Is The Mirror Image of California's

One significant condition to California's limited offering exemption is that all purchasers have a "pre-existing relationship":

All purchasers either have a preexisting personal or business relationship with the offeror or any of its partners, officers, directors or controlling persons, or managers (as appointed or elected by the members) if the offeror is a limited liability company, or by reason of their business or financial experience or the business or financial experience of their professional advisers who are unaffiliated with and who are not compensated by the issuer or any affiliate or selling agent of the issuer, directly or indirectly, could be reasonably assumed to have the capacity to protect their own interests in connection with the transaction.

Cal. Corp. Code § 25102(f)(2).

The Securities and Exchange Commission staff has grafted a similar condition into Regulation D, as explained in this recently published Compliance and Disclosure Interpretation:

Question: Does an offer of securities in a Regulation D offering to a prospective investor with whom the issuer, or a person acting on the issuer’s behalf, has a pre-existing, substantive relationship constitute a general solicitation in contravention of Rule 502(c)?

Answer: No. The existence of such a pre-existing, substantive relationship is one means, but not the exclusive means, of demonstrating the absence of a general solicitation in a Regulation D offering. See Securities Act Release No. 6825 (Mar. 15, 1989), at fn. 12. Accordingly, an offer of the issuer’s securities to the person with whom the issuer, or a person acting on its behalf, has such a relationship would not constitute a general solicitation and, therefore, would not be in contravention of Rule 502(c).

Question 256.26 (Released August 6, 2015).

Although these two requirements are similarly expressed, they are analytically different.

First, the pre-existing relationship condition under California's exemption is a stand-alone condition that is independent of the separate requirement that the offer and sale not be accomplished by the publication of any advertisement (Cal. Corp. Code § 25102(f)).

Second, California evaluates the nature of the purchaser's relationship from the perspective of the purchaser's knowledge of the issuer while the staff examines the relationship from the perspective of the issuer's knowledge of the purchaser.  Thus, California's rule is:

The term “preexisting personal or business relationship” includes any relationship consisting of personal or business contacts of a nature and duration such as would enable a reasonably prudent purchaser to be aware of the character, business acumen and general business and financial circumstances of the person with whom such relationship exists.  A relationship of employer-employee, or as a security holder of the issuer, or as a customer of a broker-dealer, investment adviser or other person, does not necessarily involve contacts of a nature which are sufficient to establish a “preexisting personal or business relationship” within the meaning of Section 25102(f).  This subsection does not create any presumption that relationships not falling within its terms are not within the statutory language, and the determination of whether or not such a relationship is within the statutory language shall be made without reference to this subsection.

10 CCR § 260.102.12(d)(1).  In contrast, another recently released CD&I provides:

Question: What makes a relationship “substantive” for purposes of demonstrating the absence of a general solicitation under Rule 502(c)?

Answer: A “substantive” relationship is one in which the issuer (or a person acting on its behalf) has sufficient information to evaluate, and does, in fact, evaluate, a prospective offeree’s financial circumstances and sophistication, in determining his or her status as an accredited or sophisticated investor.  Self-certification alone (by checking a box) without any other knowledge of a person’s financial circumstances or sophistication is not sufficient to form a “substantive” relationship.

Question 256.29, (Released August 6, 2015).

Caveat to readers:  Both exemptions are complicated and this brief blog touches on only one issue.  If you aren't knowledgeable in securities law matters, you should consult with an attorney who is.


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30172DBAB0084D3A8F39D7AF0A8E79BC.ashx Keith Paul Bishop
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