Note on Preparation and Content of Placement Memorandum ('PPM')

Joseph W. Bartlett, Special Counsel, McCarter & English, LLP

The early rounds of financing entail the issuance of securities in "private placements," transactions exempt from registration under the Securities Act of 1933 in accordance with one or more statutory exemptions. Most source materials suggest that the use of private placement memoranda is essential in private placements. [1]

The argument, properly phrased, breaks out into three major parts. A private placement memorandum (PPM) is required:
  1. To establish (and/or buttress) the claim for exemption from registration under the Securities Act, this because of the disclosure requirements in Regulation D for transactions in which non-accredited investors participate.

  2. To reduce exposure to liability for misstatements or, more importantly, omissions under the antifraud provisions of state or federal law. The memorandum, including the disclaimers, is a written record of what was and was not said.

  3. To help sell the security.

If the foregoing reasons are persuasive, the underlying assumption is that the private placement memorandum (for a nonpublic company at least) will contain much the same type of information that a public registration statement would provide, either on Form SB-2 or Form S-1, an assumption based on the observation that:

  1. The SEC is the most influential voice, next to the courts, on what Congress meant in enacting the antifraud sections (principally §11, 12(2), and 17(a) of the '33 Act and 10(b) of the Securities Exchange Act of 1934), and its expertise infiltrates state proceedings as well.

  2. The SEC requires a certain quantum of information for public offerings (and a similar amount for certain private offerings).

  3. Prudent issuers and their counsel will follow what the SEC suggests, even if not required to do so by the letter of the law.

The counterarguments are as follows:

  1. The SEC does not require any specific quantum of information for the exemption to apply if the offering is only to accredited investors and otherwise fits within the four corners of Regulation D. If the Commission had wanted so to require, it knew how to say so.

  2. The preparation of a document containing all the information required by Regulation S-K is expensive. If the issuer is going to that expense anyway, why not register the offering publicly? [2]

  3. The antifraud cases, taken as a whole (and there are not many outside the area of actual fraud) do not generally expound on the issue of inadequate disclosure if "smart" investors are exclusively involved. Indeed, reading the Livens, Zobrist, and Zissu cases [3] as precedents, one could argue that a disclosure only of the risk factors involved in the offering is sufficient, assuming that the issuer exercises control over the other principal points, that is, no "general" solicitation, only accredited and/or "smart" investors. Those decisions have been buttressed by cases relying on the Second Circuit's articulation of the so-called "bespeaks caution" doctrine in public disclosure statements and the Private Securities Litigation Reform Act.

  4. The influential Ralston Purina [4] case stresses "access" to information in the hands of investors to fend for themselves. If the investors are venture capital funds, the managers of the same will usually do their own due diligence.

  5. If counsel purports to follow Regulation S-K and Form S-1 and makes a mistake, it is arguable that the issuer is worse off–trapped by an undisputed omission in a document counsel concedes should have been prepared–than if counsel has simply put the unexpurgated information about the issuer in a file cabinet and shoved it in the general direction of the investors. [5] The problem is exacerbated if an initial public offering is just around the corner. The existence of a contemporaneous private memorandum may raise questions whether the issuer is being consistent in its presentations.

  6. In fact, millions (perhaps billions) of dollars worth of securities are placed privately without the preparation of more than a rudimentary PPM, in many cases none at all. The classic examples of laconic disclosure are the private placement memoranda used to raise venture capital for the venture partnerships themselves.

There is no right answer to the question except in certain specific instances. Thus, if a placement in excess of $1 million is made to one or more unaccredited investors, then a private placement memorandum is obviously in order. Regulation D does not specify that the information be assembled in one document, [6] but there is no apparent reason not to do so–indeed, no reason not to follow Regulation S-K as closely as possible.

However, in offerings qualified under Regulation D, solely to accredited investors and exempt in the states, Rule 506 offerings, the question of the quantum of disclosure is open. Counsel is bound to inform the issuer of the risks, but the trade-off–exposure versus expense–is pertinent. There can be less expensive, and perhaps, more effective, methods of informing the investors than slavishly following the SEC form: for example, an all-day seminar at the company's headquarters, with participants from company management, accountants, counsel, and financial consultants. [7]

In short, the quantum of printed disclosure can be approached on a case-by-case basis. What information do these investors need, and what is the best and most efficient way to get it to them? As the question suggests, the answer will depend on the type of offering and type of investors involved. [8] The most compelling legal case for a PPM occurs when the issuer is not dealing face-to-face with all the investors, as in prefabricated partnerships offering interests in managed assets such as real estate or oil and gas. Caution dictates that measures should be taken to ensure that the investors farthest out in left field get all available information; the fact that the lead investor is well informed is not a solid defense against a suit by another investor not formally represented by the knowledgeable party. On the other hand, when there are only a few offerees who are sophisticated and able to interrogate the issuer efficiently, the balance of risks obviously changes.

[1] "Even when a private placement memorandum is not required to establish an exemption from registration, it serves to protect the issuer from antifraud violation claims under 12(2) and 17(a) of the Securities Act of 1933, as amended, and under 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder." Halperin, Private Placement of Securities 7.2 (1984) [hereinafter Halperin].

[2] Some issuers prefer, given the choice, to organize a given financing as a public offering because the terms become, in effect, nonnegotiable once the registration statement becomes effective. Usually such issuers are already public companies, entitled to use short-form registration statements on Form S-3.

[3] Livens v. William D. Witter, Inc., 374 F. Supp. 1104 (D. Mass. 1974); Zobrist v. Coal-X, Inc., 708 F.2d 1511 (10th Cir. 1983); Zissu v. Bear, Stearns & Co., 627 F. Supp. 687 (S.D.N.Y. 1986). The district court's opinion in Zissu was modified on appeal, the court holding that the indemnification clause was not specific enough to support an award of attorney's fees, but that the award was supportable under Fed. R. Civ. P. Rule 11(e). 805 F.2d 75 (2d Cir. 1986). The Zobrist case has now been followed in a number of other courts, an example being the opinion of the Court of Appeals for the First Circuit in Kennedy v. Joseph Thawle & Co., 814 F.2d 798 (1st Cir. 1987). That case, involved a claim that defendants had made oral representations concerning the safety of the investment in the face of a "risk factors" section, which disclosed that the investment "involves a high degree of risk." A number of cases are collected in Haft, Using the Offering Memorandum as a Defense Against Allegations of Oral Misrepresentation in Violation of Rule l0b-5 and Section 12(2), 2 Investment Ltd. Partnerships L. Rep. 129 (Jan. 1989).

[4] SEC v. Ralston Purina Co., 346 U.S. 119 (1953). Ralston Purina considered the application of the 4(2) exemption.

[5] If Regulation D protection is lost and no other exemption is available, a violation has necessarily occurred unless the error qualifies as an insignificant deviation under Rule 508. See Ch. 4. By way of contrast, a public offering floated on the strength of an incomplete prospectus is still a registered public offering; the defendants can argue about the materiality of the omissions and, in some cases, due diligence, but an open-and-shut case has not been established. The problem with complying exactly with a set of statutory precepts is fundamental. To conform to a statutory format, one must track the statute and the cases interpreting the statute with elegant care. Failing to do so to the letter is inexcusable. It should be kept in mind that the sale of unregistered securities without an exemption can be a criminal act. '33 Act, 24.

[6] Regulation D; Rule 502(b)(2)(i)(A)(up to $5 million); Rule 502(b)(2)(i)(B)(more than $5 million).

[7] For cases suggesting an issuer may satisfy its disclosure obligations by providing prospective investors with access to its own records, see, e.g., Barrett v. Triangle Mining Corp., [1975-1976 Transfer Binder] Fed. Sec. L. Rep. (CCH) 95,438 (Feb. 2, 1976); Swenson v. Engelstad, 626 F.2d 421, 427 (5th Cir. 1980).

[8]See Austin & Tanner, The Private Placement Memorandum, in Harroch, Start-Up Companies: Planning, Financing, and Operating the Successful Business Ch. 10 (1994) [hereinafter Austin & Tanner].

Joseph W. Bartlett, Special Counsel,

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