Securities Exempt from Registration under the Securities Act of 1933

<previous: Selling New Securities There are many securities which are exempt from the Securities Act of 1933—requiring neither registration nor a prospectus. There are several reasons why securities may be exempt from registration requirements:

Government Securities

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U.S. government securities—Treasuries—and municipal bonds are all exempt from registration.

Intrastate Offerings

An intrastate offering is an offering made only to the residents of a state by a corporation in that state. The offering must be registered in the state, and it must comply with SEC Rule 147:

Resale is permitted only:

Life Insurance

Most life insurance contracts are exempt, except for those contracts that have investment risk, such as variable life policies and variable annuities.

Commercial Paper and Bankers Acceptances

Commercial paper is exempt from registration if its term is 270 days or less; and bankers acceptances, if the term 180 days or less.

Regulation A

Regulation A of the Securities Act of 1933 (aka Reg A) exempts small offerings of securities from the regular SEC registration if these conditions are met:

Private Placements

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A private placement is the sale of securities to wealthy or sophisticated investors but not to the general public. Private placements are exempted from SEC registration under Regulation D of the Securities Act. Some broker-dealers — sometimes referred to as private placement agents — specialize in private placements. Nonetheless, private placement agents are required to be registered by the SEC even though the securities that they sell are usually exempt from registration requirements.

Regulation D

The details of Reg D are explained in Rules 501 to 506. No public advertisements or solicitations for a Reg D issue are allowed. A tombstone ad may provide notice of the completion of an offering, but not the offering itself.

Rule 501: Definition of an Accredited Investor

Securities are exempt if sold to accredited investors, who are basically individuals or institutions that have a lot of money and the financial wherewithal to invest in risky unregistered securities. Accredited investors include:

Although the SEC does not require that a disclosure document be offered to accredited investors, the issuer will usually provide a Private Offering Memorandum instead. After all, even accredited investors want to know some details about what they are investing in.

A nonaccredited investor, who the law presumes does not have sufficient knowledge of financial matters to evaluate the risks and merits of a private placement, must have a purchaser representative who does have the necessary expertise to evaluate any private placement that a nonaccredited investor is considering. A purchaser representative may not be affiliated with the issuer unless he is related to the investor.

Rule 503 — Form D

The issuer must file a Form D within 15 days after the commencement of a Reg D offering.

Rule 504

A non-reporting company can raise up to $1,000,000 from any number of individuals, accredited or not, without a SEC registration.

Rule 505 — Purchaser Limitation Rule

A corporation can raise up to $5,000,000 within a 12-month period from any number of accredited investors, but no more than 35 non-accredited investors.

A non-accredited investor is anyone or organization who is not an accredited investor. However, a married couple counts as 1 non-accredited investor, as well as any purchase of issues under the Uniform Gifts to Minors Act (UGMA) for their dependent children. A partnership that was not formed for a Reg D investment is considered 1 non-accredited investor; if the partnership was formed expressly for this investment, then the number of non-accredited investors depends on the status of each partner.

Rule 506 — Investment Sophistication

The dollar limitation of Rule 505 can be waived if the non-accredited investors are sophisticated investors who have had prior experience with a Reg D offering, or they are represented by a purchaser representative who has, such as an investment adviser, accountant, or attorney.

Rule 502

Rule 502 restricts general solicitation or advertising for a private offering, stating specifically that “neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising….” This rule may apply if the media finds out about the offering and publishes it widely, creating a demand for the private offering.

Case Study — Media Involvement May Violate Rule 502

In early 2011, Goldman Sachs was going to offer a beneficial interest in shares of Facebook to some of its wealthy clients. Although Goldman did not solicit or advertise the offering, the media found out about it and published it widely, creating a potential risk that the SEC would sue it as a violation of the law. Goldman Sachs then decided to offer the shares to only foreign investors. Although Goldman probably would have won if the SEC did bring charges and even if it lost, only the offering price would have to be refunded to its clients if they asked for it, Goldman decided not to tarnish its reputation further with another lawsuit by the SEC nor jeopardize a planned initial public offering by Facebook, probably in 2012.

Source: Why Did Goldman Blink on Facebook Investment?

Rule 502 also defines 2 specific violations of Reg D:

Aggregation: when the dollar values exceed the limitations imposed by Rules 504 and 505.

Integration: when the number of non-accredited investors exceeds the purchaser limitation of Rules 505 and 506.

Regulation S

Regulation S allows United States companies to sell private shares of its stock to foreign investors without registering the shares with the SEC. However, Regulation S does not allow any directed selling efforts in the United States nor does it allow "any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States for any of the securities being offered…," nor any indirect offerings or distributions after the foreign sale.

SEC Rule 144 — Limitations on the Resale of Restricted Stock and Control Stock

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Restricted securities are securities acquired in unregistered, private sales from the issuer or from an affiliate of the issuer. Investors typically receive restricted securities through private placement offerings, Regulation D offerings, employee stock benefit plans, as compensation for professional services, or in exchange for providing start-up capital to the company. Rule 144(a)(3) identifies what sales produce restricted securities. Restricted stock will usually have the restrictive legend, "restricted", on the certificates to serve as notice that their resale is restricted.

Control stock is stock owned by a control person (aka insider, affiliate), who is a corporate director or officer, or a stockholder with more than 10% of the voting stock, or the spouses of the aforementioned.

SEC Rule 144 places limitations on any resale of restricted securities. Control stock is also restricted; however, control stock certificates usually do not have the restrictive legend. Although these restrictions can be removed by fully registering the security, the time and expense of a full registration is usually prohibitive. However, control persons can sell normally restricted stock without restrictions if sold as part of a registered primary offering by the issuer. No restricted stock can be sold unless the issuer is current in filing all required financial statements to the SEC.

Before restricted stock can be resold:

  1. The seller must have had the fully paid stock for 1 year.
  2. The issuer has complied with the periodic reporting requirements of the Securities Exchange Act of 1934.
  3. If the quantity of the stock exceeds 500 shares or $10,000 in value, then he must also file a Form 144, Notice of Proposed Sale, with the SEC with the details of the sale and compliance with Rule 144. The sale must take place within a 90-day period; otherwise another Form 144 must be filed that will cover another 90 days.
  4. The total value of an exchange-traded stock cannot exceed the greater of 1% of the issuer's outstanding stock, or the average weekly volume for the preceding 4 weeks. If the stock is only traded over the counter, then the sale cannot exceed 1% of the issuer's outstanding stock.
  5. The stock must be sold as an ordinary brokerage transaction with the regular commission charged. Neither the seller nor the broker can solicit orders to buy the securities.

Exceptions to the 144 requirement include the resale by a member firm in an agency capacity, or if a market maker in the security purchases the issue as a principal for his own account.

Note that even if the above conditions are satisfied, restricted stock cannot be sold to the public unless the restrictive legend is removed from the certificate. Only the transfer agent can do this, with the consent of the issuer.

There is no minimum holding period for selling control stock if it was acquired in the open market. Also, if a non-affiliate has held restricted stock for at least 2 years, then there is no filing requirements and no selling restrictions.

Statutory Underwriter

Any issuer, underwriter, or investor who violates the Securities Act of 1933 is known as a statutory underwriter, which is an underwriter defined by law, whether they actually are underwriters or not, and often involves someone selling restricted stock in violation of the statute. If they satisfy the legal definition of an underwriter, then they are subject to the laws regulating underwriters.

Rules 144A and 145 under the Securities Act of 1933

Securities Act (SEA) Rule 144A permits the sale of unregistered securities to qualified institutional buyers (QIB), which are institutions—banks, insurance companies, etc.—that invest at least $100 million in securities from issuers not affiliated with the QIB. This is how most unregistered foreign securities are sold in the United States.

SEA Rule 145 applies Rule 144 protections if the securities were acquired because of a recapitalization: merger, consolidation, transfer of assets, or a reclassification that was not a result of a stock split or reverse split.

PORTAL

The Private Offerings, Resales, and Trading through Automated Linkages (aka PORTAL) is an electronic system providing security descriptions and price information for Rule 144A securities. PORTAL was created by the NASD to enhance the distribution and liquidity of 144A securities.

SEC Rule 12g3-2(b)

Rule 12g3-2(b), issued by the SEC, allows a foreign company to get an exemption from registering securities under the Securities Exchange Act of 1934 that will be offered privately to institutional investors in the United States. The exemption is granted if the offering will not be listed on an exchange and is not a primary offering, and if the information that is public in the home country of the issuer is either made available to the SEC or is posted on the company's website in English.

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Private Investment in Public Equity Securities (PIPES)

Private investment in public equity securities (PIPES) are unregistered securities, which can be stock or convertible debt, issued by small-cap, high growth companies that are sold in a private placement to institutional investors at a 5% - 15% discount to the issuer's common stock. The company then tries to register the PIPES with the SEC so that they can be sold to the public by the original investors. PIPES allow a small company—which cannot get loans or more traditional financing because the company is too small, unproven, or too heavily in debt—to avoid the time and expense of a public offering, and receives immediate cash.

Although PIPES have surged recently, the SEC has significantly slowed the registration of these securities because of the risks, which include insider trading and the significant dilution of the common stock, which can lower stock prices. Often, the number of shares issued as PIPES is more than the number outstanding, so the SEC has been reluctant to register more shares than 33% of the public float—the number of shares held by the public, to prevent significant dilution and the consequent undermining of the common stock price.

The SEC is also leaning toward treating the resale of the securities as a more heavily regulated primary offering rather than as a secondary offering. The SEC may provide more information, in 2007, as to when the resale of PIPES can be considered a primary offering or a secondary offering.

SEC Slows Flow of PIPE Deals to a Trickle - WSJ.com