Securities Registration, Exempt Securities, and Exempt Transactions
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Introduction This chapter is typically the section that gives most students a difficult time and may mean the difference between successfully completing the exam and having to retake it at a later time. All securities that are sold to state residents must either be:
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Exempt securities are exempt from the registration requirements of the Securities Act of 1933. Exempt securities are not exempt from the antifraud provisions of the USA. Exempt securities are:
Nonexempt securities become federally registered by submitting a registration statement to the Securities and Exchange Commission (SEC). Nonexempt securities must also register in the states in which the securities will be sold. The three methods of registering securities in a state are:
It is important to understand how the three types of securities registration differ and under what circumstances the different registration methods are used.
Registration of IPOs Through Coordination
When a company first sells stock to the public during an initial public offering (IPO), the company must file a registration statement with the SEC. The company must also file documents with the state securities administrator in the states where the issue will be sold. Most IPOs will register with the state securities administrator at the same time that they register with the SEC. This process of simultaneous registration is known as coordination. The following must be submitted to the administrator:
If an amendment has been made to the federal registration, it must also be made to the state registration. A security’s state registration will become effective at the time the federal registration becomes effective as long as no stop order has been issued and the documents have been on file with the state for the minimum number of days (usually 10 to 20 days). It is important to note that a state registration may not become effective prior to the security’s federal registration becoming effective.
Registration Through Notice Filing
The National Securities Market Improvement Act of 1996 withdrew the states’ authority to require the registration of investment companies registered under the Investment Company Act of 1940. The states preserved the right to require investment companies to file a notice and pay a fee. When the issuer of a security notice files with the state securities administrator, the following must be submitted:
Even though the state securities administrator no longer maintains jurisdiction over the registration process of the securities, the administrator still maintains broad investigative powers over any suspected fraudulent sales practices relating to the securities. The administrator may investigate the firms and agents that offer the securities for sale to investors within their state. Notice filing may also be used by other federally covered and federally registered securities that meet the minimum requirements. The administrator may require that an issuer of a federally covered security trading on an exchange file all information with the SEC and submit a consent to service of process prior to offering any securities to state residents. A security that is federally registered and trading on the OTC bulletin board or on the pink sheets may be federally registered but may not meet the minimum criteria to notice file.
Registration of Non-Established Issuers/Registration Through Qualification
Securities of issuers that do not meet the requirements for registering through notice filing and that are not an IPO must register through qualification. Securities of issuers that will be sold only in one state through an intrastate offering will also be registered through qualification. Registration through qualification is the most complex method of registration. The issuer must file a statement containing all of the information required by the state securities administrator. It may include:
A securities registration under qualification becomes effective when the administrator so orders.
The following apply to all types of securities registration:
The following apply to registration though coordination and qualification:
Exempt Securities/Federally Covered Exemption
The National Securities Market Improvement Act of 1996 provided federally covered exemptions for securities that have met the stringent listing requirements of any U.S. stock exchange, including the Nasdaq stock exchange. An issuer whose common stock is listed on a centralized U.S. stock exchange, such as the NYSE or the Nasdaq stock exchange, is provided an exemption for all of its securities, regardless of their type. An exemption from state registration is also provided to:
Certain securities are exempt from state registration and sales literature requirements because the issuer is exempt. Examples of exempt issuers are:
Sometimes a security that would otherwise have to register is exempt from state registration because of the type of transaction that is involved. The way in which the securities are sold removes the securities from the jurisdiction of the administrator. The following are all exempt transactions.
Private Placements/Regulation D Offerings
A private placement is a sale of securities that is made to a group of accredited investors and the securities are not offered to the general public. Accredited investors include institutional investors and individuals who:
or
or
Sales to nonaccredited investors are limited to 10 in any 12-month period at the state level, and 35 nonaccredited investors at the federal level. No commission may be paid to representatives who sell a private placement to nonaccredited investors (and higher net worth individuals and institutions). All investors in private placements must hold the securities fully paid for at least six months.
The limits on the amount of money that may be raised under the various regulation D offerings are as follows:
Regulation 504 D allows issuers to raise up to $10 million.
Regulation 506 D allows issuers to raise an unlimited amount of capital.
Transactions with Financial Institutions
All transactions with financial institutions are exempt. The USA was designed to protect the individual investor, not the sophisticated financial institution. Financial institutions include:
Transactions with Fiduciaries
All transactions with fiduciaries are exempt from registration with the administrator. Transactions with any of the following are considered transactions with fiduciaries and are exempt:
Transactions with Underwriters
All transactions with underwriters of securities are exempt from state registration. For example, if XYZ Corporation is selling 10,000,000 shares of its common stock to its investment bank under a firm commitment underwriting agreement, the transaction is an exempt transaction.
Unsolicited Orders
All orders that are executed through a broker dealer at the sole request of the customer are considered unsolicited orders, and the securities if not registered within the state are exempt from registration. The administrator may require proof that the order was unsolicited and may require that the customer sign an acknowledgment due to the fact that the unsolicited order is an exempt transaction.
Transactions in Mortgage-Backed
Securities
Because of the high quality of the collateral, transactions in mortgage-backed securities are exempt so long as the entire mortgage or deed of trust is sold as a unit in the transaction.
Pledges
Should a person pledge securities as collateral for a loan the pledge does not constitute a sale. Additionally, should the borrower default on the loan, the person who now has ownership of the securities by way of default may sell those securities without being required to register the securities to recoup his or her losses.
Offers to Existing Securities Holders
Transactions with existing holders of:
These transactions with existing securities holders are all exempt provided that no commission was paid directly or indirectly for soliciting the security holder.
Preorganization Certificates
Certain regulations may require that a corporation receive a minimum level of capital in order to be formed. A preorganization certificate is an agreement to purchase securities prior to the formation of a corporation. The offer or sale of the certificate is exempt if no commission was received for soliciting the sale. The number of subscribers may not exceed 10, and the subscriber may not make any payments.
Isolated Nonissuer Transactions
An agent or a broker dealer may occasionally recommend a security to a client that is not registered in the client’s state of residence as long as it is an isolated event. An isolated transaction means one or very few are performed per year per broker dealer. The number of transactions that qualifies as isolated transactions varies from state to state. An isolated nonissuer transaction may also include a transaction between two individuals without the use of a broker dealer. In this type of transaction, the owner of the securities may sell the securities to another interested party directly.
Nonissuer Transactions
A nonissuer transaction is a transaction of publicly traded securities and is exempt if the issuer meets the following requirements:
or
or
Rule 147 pertains to offerings of securities that are limited to one state. Because the offering is being made only in one state, it is exempt from registration with the SEC and is subject to the jurisdiction of the state securities administrator. In order to qualify for an exemption from SEC registration, the issue must be organized and have its principal place of business in the state and meet at least one of the following business criteria:
All purchasers must be located within the state and must agree not to resell the securities to an out-of-state resident for 6 months.
If the issuer is using an underwriter, the broker dealer must have an office in that state.
The SEC has also adopted Rule 147A, which is largely identical to Rule 147. However, Rule 147A allows companies that are incorporated or organized out of state to use the Rule 147 exemption. Rule 147 A also allows issuers to use the internet and to advertise securities being offered Through rule 147. Additionally, offers may be made to purchasers while they are out of state. However, all sales are still limited to investors residing in the state where the offering is being conducted.