Transactions & Exempt Transactions

So, commercial paper, T-Notes, and municipal bonds are exempt securities. They are good to go without any paperwork being filed with the SEC. There are also transactions that qualify for exemptions, called exempt transactions.

Unlike an exempt security, an exempt transaction must be claimed by the issuer with some paperwork to back up what they did or are about to do. Under Regulation A, for example, an issuer can sell up to $5,000,000 worth of securities in a year without having to jump through all the usual hoops. Rather than filing a standard registration statement, the issuer files an offering circular, a much more scaled-down document.

The SEC oversees interstate commerce, meaning commerce among many states. Therefore, if the issuer wants to sell only to residents of one state, the SEC doesn't get involved. There is already a state securities regulator who can deal with this one. Therefore, intrastate offerings are exempt if they match this statement, "Any security which is a part of an issue offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory."

These offerings are registered with the securities regulator of that state or territory rather than the federal government. The state where the offering takes place is where the issuer is located and doing business. The issuer doesn't just pick a state at random in which to offer the securities.

These intrastate offerings are performed under an exemption to the Securities Act of 1933 called Rule 147. As the rule states, the offering is not required to be registered with the SEC provided "That the issuer be a resident of and doing business within the state or territory in which all offers and sales are made; and that no part of the issue be offered or sold to non-residents within the period of time specified in the rule." So, if the issuer's business is in the state, 80% of its gross revenue is derived there, 80% of its assets are located there, and 80% of the net proceeds will be used in that state, a Rule 147 exemption can be claimed to avoid registration with the SEC. But, as the second requirement clarified, the buyers can't sell the security to a non-resident for a time specified by the rule which is nine months.

To be an eligible investor, the individual must be a resident of the state, or a partnership, LLC, corporation, trust or other entity that has its principal office within the state. And, if an entity is formed to acquire part of the offering, it would only be eligible if all beneficial owners of the organization are residents of the state or territory (e.g. Puerto Rico).

The SEC is out to protect the average investor from fast-talking stock operators. But, the SEC doesn't provide as much protection to sophisticated investors such as mutual funds, pension funds, or high-net-worth individuals. If anybody tries to scam these investors, they'll be in just as much trouble as if they scammed an average investor, but the SEC doesn't put up as much protection for the big, institutional investors, who can usually watch out for themselves. Therefore, if the issuer wants to avoid the registration process under the Act of 1933, they can limit the offer and sale of the securities primarily to these accredited investors. Accredited investors include institutions such as:

•    banks
•    broker-dealers
•    insurance companies
•    investment companies
•    small business investment companies (Venture Capital)
•    government retirement plans
•    company retirement plans of a certain minimum size

An accredited investor also includes an executive officer, director, or general partner of the issuer. If Amazon wants to sell shares of Amazon to Jeff Bezos and the members of the board, how much protection do these investors need from the company they run?

Accredited investors also include individuals or married couples with at least $1 million net worth excluding the value of their primary residence. If not relying on net worth, an accredited investor can qualify based on income. Individuals earning at least $200,000 a year in the most recent two years and married couples earning at least $300,000 with a reasonable expectation of making at least that much this year —are also accredited investors.

Exemptions relate to registration requirements. Whether an offer is registered, it is subject to anti-fraud regulations. As Regulation D announces from the start, "Regulation D relates to transactions exempted from the registration requirements of section 5 of the Securities Act of 1933. Such transactions are not exempt from the anti-fraud, civil liability, or other provisions of the federal securities laws. Issuers are reminded of their obligation to provide such further material information, if any, as may be necessary to make the information required under Regulation D, in light of the circumstances under which it is furnished, not misleading."

Under Regulation D an issuer finds various offerings that can be completed without the usual registration requirements having to be met. Let's look at the best-known exempt transactions, performed under either Rule 505 or 506.

A Reg D/private placement transaction is exempt based on the issuer offering to an unlimited number of accredited investors but only to a maximum of 35 non-accredited purchasers. Under Rule 505 the issuer can only offer and sell up to $5 million in a 12-month period. The issuer must inform all investors that they will receive "restricted securities" that cannot be sold until after a 6-month minimum holding period, which we discuss in just a few paragraphs. Also, there can be no general solicitation or advertising in connection with this private placement offering.

Even though the issuer isn't filing a registration statement with the SEC, it still must provide information to the investors. As the rule states, "Rule 505 allows companies to decide what information to give to accredited investors, so long as it does not violate the anti-fraud prohibitions of the federal securities laws. But companies must give non-accredited investors disclosure documents that generally are equivalent to those used in registered offerings. If a company provides information to accredited investors, it must make this information available to non-accredited investors as well. The company must also be available to answer questions by prospective purchasers."

And, even though there is no registration statement required, when the offering is completed, issuers must file a Form D that discloses the basic facts of the offering. For example, by looking up their Form D, we see that Five Guys sold $10 million of stock through a private placement in which they tried to raise $15 million. Beyond that, we see little information, only that Five Guys takes in somewhere between $25 million and $100 million in revenue. If Five Guys does an IPO someday, then we will have access to all pertinent information on the issuer.

If the issuer doesn't want limits placed on the amount of money raised, they utilize Rule 506 instead. Then, they decide if they want to solicit investors and advertise the offering to prospects or not.

Under one type of Rule 506 offering the issuer will offer and sell to up to 35 non-accredited purchasers, but unlike under Rule 505 the issuer must reasonably believe the non-accredited purchasers are either sophisticated or are relying on an independent (from the issuer) purchaser representative who can explain the risks and rewards of the deal. Because the issuer will use non-accredited purchasers here, no solicitation or advertising is allowed.

If the issuer wants to be able to solicit investors, they must limit them to accredited investors only. This is the other type of exempt transaction under Rule 506.

No matter which of these exemptions is used, the issuer must file a Form D - Notice of Exempt Offering of Securities. And, investors receive "restricted shares" subject to mandatory minimum holding periods.

The securities offered and sold through a private placement are not required to be registered, but FINRA requires member firms to file a copy of the private placement memorandum (PPM) with their Firm Gateway. The PPM must be filed no later than 15 calendar days after the first sale is made. Or, if no PPM is going to be used with the offering, that fact must be reported to FINRA.


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