Exemptions and Private Placements

Exempt securities

A security exempt under Section 3 never needs to be registered under the Securities Act. The list the exam expects:

United States government securities, and securities issued or guaranteed by a federal agency.

Municipal securities — the exemption that created the entire regulatory arrangement described in Module 4.

Securities issued by banks. Note the boundary: this covers the bank's own securities, not securities the bank sells for others, and it does not extend to a bank holding company's stock.

Securities issued by non-profit religious, educational and charitable organizations.

Insurance policies and fixed annuity contracts, issued by an insurer subject to state supervision. Variable contracts are not exempt, because the holder bears investment risk — the point made in lesson 5.4.

Commercial paper and other short-term notes arising out of a current transaction with a maturity not exceeding nine months, under Section 3(a)(3) — the source of the 270-day convention from lesson 3.5.

Intrastate offerings under Section 3(a)(11), with Rule 147 providing a safe harbour.

A critical qualification: exempt from registration is not exempt from the anti-fraud provisions. A municipal bond is an exempt security and it is still unlawful to sell one by misrepresentation. This is why MSRB Rule G-17 exists and why fraud in exempt securities is prosecuted under Section 17(a) of the 1933 Act and Rule 10b-5 under the 1934 Act.

Regulation D and private placements

Section 4(a)(2) exempts transactions by an issuer not involving a public offering, and Regulation D provides the safe harbours that make that exemption usable in practice.

Rule 506(b) permits an unlimited dollar amount, sold to an unlimited number of accredited investors and up to thirty-five non-accredited purchasers who are sophisticated — meaning they have sufficient knowledge and experience in financial and business matters to evaluate the merits and risks. General solicitation and general advertising are prohibited, which means a pre-existing substantive relationship with the purchaser is what makes the offer permissible. If any non-accredited investor participates, specified disclosure comparable to a registered offering must be provided to them.

Rule 506(c) also permits an unlimited amount, but sells only to accredited investors — and in exchange permits general solicitation, provided the issuer takes reasonable steps to verify that each purchaser is in fact accredited. Verification is an affirmative obligation; a checkbox is not enough.

Rule 504 exempts offerings up to $10,000,000 in a twelve-month period by an issuer that is not a reporting company, not an investment company and not a blank-check development stage company.

Across Regulation D, the securities purchased are restricted securities, so resale is governed by Rule 144 as covered in lesson 2.4. The issuer files a Form D notice with the SEC. And Rule 502 restricts the manner of offering and requires the issuer to exercise reasonable care to prevent the purchasers becoming underwriters — the legend and stop-transfer machinery that makes a restricted security actually restricted.

Who is accredited

Rule 501 defines the accredited investor, and the tests fall into three families.

By wealth or income, for a natural person: net worth exceeding $1,000,000, individually or together with a spouse or spousal equivalent, excluding the value of the primary residence; or individual income exceeding $200,000 in each of the two most recent years — $300,000 jointly with a spouse — with a reasonable expectation of the same in the current year.

By professional credential: a natural person holding certain professional certifications, designations or credentials designated by the Commission — which includes holders of the Series 7, the Series 65 and the Series 82 in good standing. That is a change worth knowing, and it means a registered representative can be accredited without meeting either financial test.

By status: institutions of specified kinds — banks, insurance companies, registered investment companies, business development companies, employee benefit plans above a threshold, and entities with assets above a threshold — plus directors, executive officers and general partners of the issuer, and knowledgeable employees of a private fund.

Do not confuse an accredited investor with a qualified institutional buyer. A QIB under Rule 144A is an institution owning and investing at least $100 million in securities, and is never a natural person. An accredited investor can be an individual. Questions that place a wealthy individual in a 144A offering are testing exactly this.

Regulation A, Rule 147 and Regulation S

Regulation A is an exemption for smaller public offerings, sometimes described as a mini-registration because it uses an offering circular rather than a full registration statement and requires qualification by the SEC rather than effectiveness.

Tier 1 covers offerings up to $20,000,000 in a twelve-month period, including not more than $6,000,000 by affiliate selling securityholders.

Tier 2 covers offerings up to $75,000,000, including not more than $22,500,000 by affiliate selling securityholders, and carries ongoing reporting obligations and, for non-accredited investors, investment limits based on income or net worth.

Regulation A permits testing the waters — soliciting indications of interest before filing — subject to conditions, which is a notable departure from the pre-filing silence of a registered offering.

Rule 147 is the safe harbour for the intrastate exemption in Section 3(a)(11): an offering made only to residents of a single state, by an issuer resident and doing business in that state, with resale restrictions preventing the securities leaving the state for a specified period. A single out-of-state purchaser destroys the exemption for the whole offering, which is why the residency documentation matters.

Regulation S provides a safe harbour for offers and sales made outside the United States. Securities sold under Regulation S may not be offered or sold to US persons during a distribution compliance period, and the exam's version is straightforward: Regulation S is the offshore exemption, and a US retail customer is not eligible to buy into it.

The common thread across all of these is worth stating. Every exemption is a bargain: the issuer is relieved of registration and in exchange the securities are restricted, the buyers are limited, the amount is capped, or the geography is fenced. When a question describes a customer wanting to sell an exempt security freely soon after buying it, the answer almost always involves the restriction that paid for the exemption.