Securities Exempt from Registration under the Securities Act of 1933
<previous: Selling New Securities Many securities are exempt from the Securities Act of 1933 — requiring neither registration nor a prospectus. Securities may be exempt from registration requirements because:
- the securities are considered safe because they are issued by a government authority, such as US Treasuries or municipal bonds;
- the sale of the securities is restricted to a given geographic area, usually within a state; or
- the securities are sold to accredited investors, either wealthy individuals or institutions who are considered to have the wherewithal and expertise to manage their money and to avoid fraud.
U.S. government securities — Treasuries — and municipal bonds are all exempt from registration.
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 must comply with SEC Rule 147:
- the issuer is incorporated in the state;
- at least 80% of the issuer's revenues must come from business within the state,
- at least 80% of the issuer's assets must be located in the state,
- at least 80% of the proceeds of the offering must be used in the state;
- buyers of the offering must be state residents or an entity owned by state residents.
Resale is permitted only:
- to other state residents;
- or to other buyers only after 9 months after the termination of the Rule 147 offering;
- and the certificates and offering document must specify these resale restrictions.
Most life insurance contracts are exempt, except for those contracts with 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, with a term of 180 days or less.
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:
- The public offering is not for more than $5,000,000 within a 12-month period.
- The offering statement, a simplified disclosure document, must be filed with a Regional Office of the SEC at least 10 days before the issue is offered for sale.
- The offering circular, which, like the prospectus, provides full disclosure, must be sent to each buyer of the issue at least 48 hours before the confirmation of the sale.
- The offering circular must be revised if the issue is still being offered 9 months after the initial issue, and the issuer must file a sales report of the issue with the Securities and Exchange Commission (SEC) every 6 months until the offer is terminated.
Regulation A has recently been expanded for companies in the United States or Canada by allowing offerings up to $50,000,000. The company must have a specific business plan or purpose, not just to be acquired in a merger or acquisition. This new regulation, called Regulation A+, implements Title IV of the JOBS Act by providing 2 tiers of offerings:
- Tier 1 consists of securities offerings of up to $20 million in a 12-month period. Affiliates of the issuer cannot sell more than $6,000,000 of their securities in the offering.
- Tier 2 consists of securities offerings up to $50 million in a 12-month period. Affiliates of the issuer cannot sell more than $15,000,000 of their securities in the offering.
Companies with Tier 2 offerings must:
- provide audited financial statements,
- file annual, semiannual and current event reports,
- limit total sales to non-accredited investors to 10% of the greater of their annual income or net worth.
Tier 2 securities are exempt from the mandatory registration requirements of Section 12(g) if the issuer:
- uses a SEC-registered transfer agent;
- is still subject to Tier 2 reporting requirements;
- issues current annual and semiannual reports by fiscal year-end.
- had a public float of less than $75 million at the end of its most recent semiannual period, or, if not applicable, had annual revenues of less than $50 million by its most recent fiscal yearend.
Sales by all security-holders cannot exceed 30% of an issuer’s Regulation A offering within the first 12 months following the initial offering. For offerings not exceeding $20 million, the issuer may choose Tier 1 or Tier 2. Regulation A+ also preempts state security laws regarding registration and qualification. When the issuer exceeds the dollar and Section 12(g) registration thresholds, it must register its securities within 2 years.
A private placement is the sale of securities to wealthy or sophisticated investors but not to the public. Private placements are exempted from SEC registration under Regulation D of the Securities Act. Some broker-dealers — sometimes called private placement agents — specialize in private placements. Nonetheless, private placement agents are required to be registered by the SEC even though the securities they sell are usually exempt from registration requirements.
The details of Reg D are explained in Rules 501 to 506. No public advertisements or solicitations for a Reg D issue were allowed, but the 2012 JOBS Act permitted public advertising in Reg D offerings if the securities are sold only to accredited investors and the issuer verifies their accreditation. Also, 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, individuals or institutions with a lot of money and the financial wherewithal to invest in risky unregistered securities. Accredited investors include:
- corporations, partnerships, or other organizations:
- financial institutions;
- with more than $5,000,000 of assets:
- corporations and partnerships, not formed expressly for this investment;
- non-profit organizations;
- any entity owned entirely by accredited investors;
- individuals or married couples
- corporate or partnership insiders;
- with assets worth more than $1,000,000;
- or individuals who earned at least $200,000, or $300,000 for a married couple, in the last 2 years, and expect to make at least the same amount in the current year.
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.
In 2020, the SEC Has Expanded the Definition of an Accredited Investor
In 2020, the SEC has revised Rule 501(a), Rule 215, and Rule 144A of the Securities Act to expand the definition of an accredited investor to include:
- natural persons with certain professional certifications, designations or credentials
- natural persons held in good standing with a Series 7, Series 65, or Series 82 license
- for investments in a private fund, knowledgeable employees of that fund
- limited liability companies with $5 million in assets
- SEC- and state-registered investment advisers, exempt reporting advisers, and rural business investment companies (RBICs)
- Indian tribes, governmental bodies, funds, and entities organized under the laws of foreign countries that own investments exceeding $5 million, but only if the fund was not formed for the specific purpose of investing in the securities offered;
- family offices, as defined by the SEC, managing at least $5 million in assets;
- spouse or spousal equivalent, as defined by the SEC, to enable them to pool their finances to qualify as accredited investors
- a Rule 144A qualified institutional buyer including limited liability companies and RBICs if they own at least $100 million in securities
- any other institutional investors satisfying the $100 million threshold even if they would not qualify as a qualified institutional buyer as defined by the SEC.
Rule 503 — Form D
The issuer must file a Form D within 15 days after the commencement of a Reg D offering. Form D is a brief notice listing the names and addresses of owners and stock promoters, but provides little information about the company.
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 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 must 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 the planned initial public offering by Facebook in 2012.
Rule 502 also defines 2 specific violations of Reg D:
- Aggregation: when the dollar values exceed the limits 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 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
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 limits the 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:
- The seller must have had the fully paid stock for 1 year.
- The issuer has complied with the periodic reporting requirements of the Securities Exchange Act of 1934.
- If the quantity of the stock exceeds 500 shares or $10,000 in value, then Form 144, Notice of Proposed Sale must be filed 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 to cover another 90 days.
- 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.
- 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.
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: Sales of Unregistered Securities
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.
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.