Public vs Private Offerings

Public and private offerings represent two distinct methods companies use to raise capital by issuing securities. Understanding the differences between these offerings, including their registration requirements, investor eligibility, disclosure obligations, and regulatory framework, is essential for the FINRA SIE Exam. This topic tests your ability to identify which offering type applies in specific scenarios and what rules govern each method.

Core Concepts

Public Offerings

A public offering is the sale of securities to the general public, requiring full registration with the SEC under the Securities Act of 1933. Companies must file a registration statement including a detailed prospectus that discloses financial information, business operations, risk factors, and management details. This process ensures transparency and investor protection through mandatory disclosure.

• Must register with the SEC unless an exemption applies
• Subject to full disclosure requirements under the Securities Act of 1933
• Available to all investors, both institutional and retail
• Requires a prospectus delivered to all potential investors
• Securities can be freely traded in the secondary market after the offering
• Subject to ongoing reporting obligations under the Securities Exchange Act of 1934 if the company becomes a reporting company
• Expensive and time-consuming due to legal, accounting, and underwriting costs

When to Use This

• When an exam question asks which offering type requires SEC registration and a prospectus
• When you see a scenario describing a company selling securities to "the general public" or "any investor"
• When the question mentions unrestricted resale of securities in the secondary market
• When distinguishing between offerings available to retail investors versus only accredited investors

Private Offerings (Private Placements)

A private offering or private placement is the sale of securities to a limited number of investors without SEC registration, typically relying on exemptions under Regulation D. These offerings are generally restricted to accredited investors and a limited number of sophisticated non-accredited investors. Private placements use an offering memorandum or private placement memorandum (PPM) instead of a prospectus.

• Exempt from SEC registration under Regulation D (most common) or other exemptions
• Limited to accredited investors and up to 35 non-accredited but sophisticated investors (depending on the specific exemption)
• No general solicitation or advertising permitted (except under Rule 506(c))
• Securities are restricted securities that cannot be freely resold without registration or an exemption
• Less expensive and faster than public offerings
• Requires filing Form D with the SEC within 15 days of the first sale
• No ongoing reporting requirements unless the issuer is already a reporting company

When to Use This

• When an exam question describes securities sold only to a small group of wealthy or institutional investors
• When the scenario mentions "restricted securities" or "resale restrictions"
• When you see references to Regulation D, Rule 506(b), or Rule 506(c)
• When the question asks about offerings exempt from registration

Accredited Investors

An accredited investor is an individual or entity meeting specific financial thresholds defined by SEC rules, allowing them to participate in private offerings. The SEC presumes these investors can bear the economic risk and evaluate investment opportunities without the full disclosure protections of registered offerings.

Individual qualifications (must meet at least one):

• Income exceeding $200,000 individually (or $300,000 jointly with spouse) in each of the past two years with expectation of the same in the current year
• Net worth exceeding $1 million (individually or jointly with spouse), excluding the value of the primary residence
• Holders of certain professional certifications (Series 7, Series 65, Series 82) as of 2020

Entity qualifications include:

• Banks, insurance companies, registered investment companies, and business development companies
• Employee benefit plans with assets exceeding $5 million
• Entities with assets exceeding $5 million not formed specifically to invest in the offering
• Entities owned entirely by accredited investors

When to Use This

• When a question asks who can participate in a private placement under Regulation D
• When evaluating whether an investor meets the criteria to invest in restricted securities
• When the exam tests your knowledge of income or net worth thresholds
• When distinguishing between accredited and non-accredited investor rights

Regulation D Exemptions

Regulation D provides safe harbor exemptions from SEC registration for private offerings. The most commonly tested rules are Rule 506(b) and Rule 506(c), both allowing unlimited capital raising but with different investor and solicitation requirements.

Rule 506(b):

• Permits sales to unlimited accredited investors and up to 35 non-accredited but sophisticated investors
• No general solicitation or advertising allowed
• Issuer must have a pre-existing relationship with investors or rely on intermediaries
• No requirement to verify accredited investor status (can rely on self-certification)
• Unlimited capital can be raised

Rule 506(c):

• Permits sales only to accredited investors (no non-accredited investors allowed)
• General solicitation and advertising permitted
• Issuer must take reasonable steps to verify that all investors are accredited
• Unlimited capital can be raised

When to Use This

• When a question asks about exemptions from registration for private offerings
• When distinguishing between offerings that allow general solicitation versus those that do not
• When the scenario describes verification of investor accreditation status
• When you need to identify which rule permits non-accredited investors

Comparison of Public vs Private Offerings

Comparison of Rule 506(b) vs Rule 506(c)

Restricted Securities

Restricted securities are securities acquired in unregistered private offerings that cannot be freely resold in the public market without registration or an exemption. These securities are subject to holding periods and resale restrictions under Rule 144.

• Acquired through private placements, Regulation D offerings, or employee stock compensation plans
• Legend on the certificate indicates the securities are restricted
• Cannot be resold without SEC registration or an exemption (commonly Rule 144)
• Rule 144 requires a six-month holding period for reporting companies and one year for non-reporting companies before restricted securities can be resold publicly
• Volume limitations apply to affiliates selling under Rule 144

When to Use This

• When a question asks about securities purchased in a private placement and their resale
• When the exam tests holding period requirements before resale
• When distinguishing between restricted and control securities
• When evaluating whether securities can be immediately sold in the secondary market

Form D Filing

Issuers conducting private placements under Regulation D must file Form D with the SEC within 15 days of the first sale of securities. This notice filing provides basic information about the offering and the issuer but does not constitute registration.

• Due within 15 days of the first sale
• Contains information about the issuer, offering amount, exemption claimed, and types of investors
• Filed electronically via the SEC's EDGAR system
• Failure to file does not disqualify the exemption but may result in penalties

When to Use This

• When a question asks about notice requirements for private placements
• When the exam tests procedural compliance after a Regulation D offering
• When distinguishing between registration statements (public offerings) and notice filings (private offerings)

Commonly Tested Scenarios / Pitfalls

1. Scenario: A startup technology company wants to raise $10 million quickly from a small group of wealthy individuals and venture capital firms without the time and expense of SEC registration. The question asks which offering type is most appropriate.

Correct Approach: Choose private placement under Regulation D (specifically Rule 506(b) or 506(c)). Private placements are exempt from registration, faster, and designed for raising capital from accredited investors.

Check first: Confirm the investors are accredited (wealthy individuals and VC firms typically are) and that the company wants to avoid registration.

Do NOT do first: Do not assume a public offering is required just because the amount is large ($10 million). Public offerings are not defined by capital amount but by who can invest and registration requirements.

Why other options are wrong: A public offering would require SEC registration, be time-consuming and expensive, and is unnecessary when the company only needs to raise capital from a small group of sophisticated investors.

2. Scenario: An investor purchased shares in a private placement six months ago. The investor now wants to sell the shares on the open market. The question asks whether the investor can immediately resell the shares.

Correct Approach: The investor cannot immediately resell because the shares are restricted securities. If the issuer is a reporting company, the investor must hold the shares for six months under Rule 144 before resale; if non-reporting, one year.

Check first: Identify that the shares were acquired in a private placement, making them restricted securities subject to holding periods.

Do NOT do first: Do not assume the investor can sell immediately just because six months have passed without confirming whether the issuer is a reporting company.

Why other options are wrong: Shares from a public offering are freely tradable, but private placement shares are restricted and subject to Rule 144 holding periods and other conditions.

3. Scenario: A company conducting a Rule 506(c) offering advertises the investment opportunity on social media and accepts investments from several individuals who claim to be accredited. The question asks what the issuer must do regarding investor status.

Correct Approach: The issuer must take reasonable steps to verify that all investors are accredited. Under Rule 506(c), self-certification is not sufficient; verification is mandatory.

Check first: Identify that the offering is under Rule 506(c), which permits general solicitation but requires verification of accredited status.

Do NOT do first: Do not rely solely on the investors' self-certification, as this is only acceptable under Rule 506(b), not 506(c).

Why other options are wrong: Rule 506(b) allows self-certification but prohibits general solicitation; Rule 506(c) allows solicitation but requires verification, so mixing the two approaches violates the exemption.

4. Scenario: A company files a registration statement with the SEC and delivers a prospectus to all potential investors before selling securities. The question asks which offering type this describes.

Correct Approach: This is a public offering. The registration statement and prospectus delivery are hallmarks of public offerings under the Securities Act of 1933.

Check first: Look for keywords like "registration statement" and "prospectus," which indicate SEC registration and a public offering.

Do NOT do first: Do not confuse an offering memorandum or PPM (used in private placements) with a prospectus (used in public offerings).

Why other options are wrong: Private placements are exempt from registration and do not use a prospectus; they use offering memoranda and are limited to specific investors.

5. Scenario: An individual has an annual income of $180,000 and a net worth of $900,000 (excluding primary residence). The question asks whether this individual qualifies as an accredited investor for a private placement.

Correct Approach: The individual does not qualify as an accredited investor. Income must exceed $200,000 individually (or $300,000 jointly) or net worth must exceed $1 million (excluding primary residence).

Check first: Compare the individual's income and net worth against the accredited investor thresholds: $200,000/$300,000 income or $1 million net worth.

Do NOT do first: Do not assume the individual qualifies just because they have high income or net worth without checking the specific thresholds.

Why other options are wrong: The individual falls short of both income ($180,000 < $200,000) and net worth ($900,000 < $1,000,000) requirements, so they cannot participate as an accredited investor unless the offering permits non-accredited investors under Rule 506(b).

Step-by-Step Procedures or Methods

Task: Determining if an offering qualifies as a private placement exempt from registration

1. Identify the number and type of investors: Are they accredited investors, and how many non-accredited investors are involved?
2. Determine if general solicitation or advertising was used: If yes, the offering must comply with Rule 506(c) and all investors must be accredited and verified.
3. Check if investor accreditation was verified: Rule 506(c) requires verification; Rule 506(b) does not.
4. Confirm the securities are restricted: Private placement securities cannot be freely resold; they are subject to Rule 144 holding periods.
5. Verify Form D was filed within 15 days of the first sale: This notice filing is required for Regulation D offerings.
6. Ensure the issuer did not exceed 35 non-accredited investors (for Rule 506(b) only): Rule 506(c) does not permit any non-accredited investors.

Task: Evaluating whether an investor qualifies as accredited

1. Check individual income: Does the individual have income exceeding $200,000 individually or $300,000 jointly with spouse in each of the past two years, with expectation of the same this year?
2. Check net worth: Does the individual (or jointly with spouse) have net worth exceeding $1 million, excluding the value of the primary residence?
3. Check professional certifications: Does the individual hold a Series 7, Series 65, or Series 82 license?
4. If the investor is an entity: Does the entity have assets exceeding $5 million and was it not formed solely to invest in this offering? Or is it a bank, insurance company, registered investment company, or owned entirely by accredited investors?
5. If any one criterion is met, the investor qualifies as accredited.

Practice Questions

Q1: A company wants to raise capital by selling securities to the general public and have those securities freely tradable on an exchange. Which type of offering must the company conduct?
(a) Private placement under Rule 506(b)
(b) Public offering registered with the SEC
(c) Private placement under Rule 506(c)
(d) Intrastate offering under Rule 147

Ans: (b)
A public offering registered with the SEC is required when selling securities to the general public and when the securities must be freely tradable. Private placements are limited to specific investors and result in restricted securities; intrastate offerings have geographic limitations and also typically involve restrictions.

Q2: An individual has an annual income of $250,000 and a net worth of $800,000, excluding their primary residence. Does this individual qualify as an accredited investor?
(a) No, because net worth must exceed $1 million
(b) Yes, because income exceeds $200,000 individually
(c) No, because both income and net worth thresholds must be met
(d) Yes, because net worth exceeds $500,000

Ans: (b)
The individual qualifies as an accredited investor because their income exceeds $200,000 individually. Only one criterion needs to be met-either income or net worth. The net worth threshold is $1 million excluding primary residence, which this individual does not meet, but the income threshold alone is sufficient.

Q3: A company conducts a private placement under Rule 506(c) and advertises the offering on its website. What must the company do regarding investor accreditation?
(a) Rely on investors' self-certification of accredited status
(b) Allow up to 35 non-accredited sophisticated investors
(c) Take reasonable steps to verify all investors are accredited
(d) File a registration statement with the SEC

Ans: (c)
Rule 506(c) permits general solicitation but requires the issuer to take reasonable steps to verify that all investors are accredited. Self-certification is only acceptable under Rule 506(b), which does not permit general solicitation. Rule 506(c) does not allow any non-accredited investors, and private placements are exempt from registration.

Q4: An investor purchased restricted securities in a private placement from a reporting company. How long must the investor hold the securities before reselling them under Rule 144?
(a) Three months
(b) Six months
(c) One year
(d) Two years

Ans: (b)
For a reporting company, the holding period under Rule 144 for restricted securities is six months. For non-reporting companies, the holding period is one year. The investor cannot resell the restricted securities before the applicable holding period expires.

Q5: Which document is used in a private placement instead of a prospectus?
(a) Registration statement
(b) Offering memorandum or private placement memorandum (PPM)
(c) Form D
(d) Annual report

Ans: (b)
Private placements use an offering memorandum or private placement memorandum (PPM) to disclose information to potential investors. A prospectus is used in public offerings. Form D is a notice filing with the SEC, not a disclosure document. Registration statements are filed for public offerings, not private placements.

Q6: A company conducting a Rule 506(b) offering wants to include a few investors who are not accredited but are financially sophisticated. How many non-accredited investors can participate?
(a) None, only accredited investors are allowed
(b) Up to 10 non-accredited investors
(c) Up to 35 non-accredited investors
(d) Unlimited non-accredited investors as long as they are sophisticated

Ans: (c)
Rule 506(b) allows up to 35 non-accredited but sophisticated investors in addition to unlimited accredited investors. Rule 506(c) does not permit any non-accredited investors. There is no 10-investor limit, and unlimited non-accredited investors would violate the rule.

Quick Review

• Public offerings require SEC registration, a prospectus, and are available to all investors; securities are freely tradable.
• Private placements are exempt from registration, limited to accredited investors (and up to 35 non-accredited under Rule 506(b)), and result in restricted securities.
• Accredited investor thresholds: Income > $200,000 individual or $300,000 joint (past two years), or net worth > $1 million excluding primary residence.
• Rule 506(b): No general solicitation; unlimited accredited + up to 35 non-accredited sophisticated investors; no verification required.
• Rule 506(c): General solicitation permitted; accredited investors only; must verify accreditation.
• Restricted securities from private placements have holding periods: six months (reporting companies) or one year (non-reporting companies) under Rule 144.
• Form D must be filed with the SEC within 15 days of the first sale in a Regulation D offering.
• Private placements use an offering memorandum or PPM, not a prospectus.
• Public offerings are expensive and time-consuming; private placements are faster and less costly.
• Securities from public offerings are unrestricted; securities from private placements are restricted.