Exemption regulations

Registration exemptions

Exempt securities

There are securities that are exempt from the regulations, the registration and prospectus requirements, of the Securities Act of 1933. There are additional, but the primary ones you want to make sure to remember would include;

• Municipal securities (bonds, and municipal fund securities such as 529 plans)
• Direct government securities (treasuries, etc)
• Securities issued by banks and savings and loan (S&Ls), but not bank holding companies
• Money market securities, including commercial paper, bankers acceptances, jumbo CDs, and repos/reverse repos
• Securities that are issued by nonprofit or charitable organizations

Securities of foreign governments are not on this list. The act’s government exemption is for US issuers only: the federal government, the states and territories, and their political subdivisions and instrumentalities. A foreign country or city that sells bonds to the US public must register the offering unless the offering itself is exempt. Shares of an investment company are not on the list either, whatever the fund holds. A money market fund or a municipal bond fund owns exempt securities, but the fund is the issuer of its own shares and registers them with the SEC.

Exempt offerings

These are issuances, or some other way the securities are being offered that provides the exemption from registration requirements. There must be a good reason, and most often it’s one of the following 3 reasons;

1. It is a small amount of securities being offered, and the capital is limited (this is the rationale behind Regulation A)
2. Securities aren’t based in the US directly, offshore, or otherwise mostly handled overseas (this is the rationale behind Regulation S)
3. Private offerings of the securities, generally to limited numbers of persons, and often with qualifications for those persons to be able to participate (this is the rationale behind Regulation D)

Regulation A

A common small issuer exemption. The maximum amount that can be offered under Reg-A is $75 million, and there are 2 tiers of Reg-A. It is a narrower exemption than others, as the issuer is still required to file an offering statement with the SEC and provide an offering circular. An offering circular is going to be very similar to a prospectus, but it is not a prospectus, as this is effectively exempt from the prospectus requirements. Similar to how municipal bonds are issued with an official statement, and not a prospectus.

Reg-A tier 1 is up to $20 million issued in a 12-month period, of which no more than $6 million can be sold by selling securityholders who are affiliates of the issuer. Form 1-Z is required to report at the end of the offering, things like securities sold, proceeds, and service providers. No ongoing reporting requirements. Tier 1 needs its offering to be qualified by state regulators in the states the issuer plans to sell the securities.

Reg-A tier 2 is up to $75 million issued in a 12-month period, of which no more than $22.5 million can be sold by selling securityholders who are affiliates of the issuer. In either tier, in the issuer’s first Reg-A offering and any other qualified within a year of it, selling securityholders can account for no more than 30% of the offering. A company issuing less than $20 million, could use either tier 1 or tier 2. Tier 2 requires audited financial statements and continual reports, including final status report similar to 1-Z. Tier 2 does not need to register in the state, but they still must file the offering with the SEC. The continuing reports include the 1-K annually, 1-SA semiannually, and 1-U, as necessary for events. The 1-K is like the 10-K, the 1-SA is like the 10-Q, and the 1-U is like the 8-K forms for larger companies.

Accredited investors have no limits on what they can contribute to a Reg-A tier 2 offering, but non-accredited investors are limited to 10% of their income or net worth (whichever is higher)

Regulation D

Often referred to as a “Reg-D private placement”, this is one of the most commonly tested exemptions, as it is one of the more commonly used.

The basic rule is that no more than 35 non-accredited investors can participate, and each of them must be sophisticated: alone or with a purchaser representative, they need enough knowledge and experience in financial and business matters to evaluate the merits and risks of the investment. There are no limits to the numbers of accredited investors that can participate. We could do a Reg-D offering, and invite 10 friends or family members, the non-accredited, and then 1000 banks, insurance companies, and other financial institutions. Provided we do not sell to more than 35 non-accredited, it would fit in the exemption.

Definitions

Accredited investor

An accredited investor would include;

• Any bank, savings and loan association, any broker or dealer, any investment adviser registered federally, with a state, or relying on an exemption, any insurance company, any investment company registered under the Investment Company Act of 1940
• Any retirement plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or political subdivisions, provided such plan has total assets in excess of $5 million, any employee benefit plan defined by ERISA if decisions are made by the plan fiduciary, or if the plan has assets in excess of $5 million.
• Any director, executive officer, or general partner of the issuer, for that issuer’s securities only.
• Any natural person whose individual net worth, or joint net worth with a spouse or spousal equivalent, is more than $1 million, excluding their primary residence.
• Any natural person with individual income exceeding $200,000 (or $300,000 joint with a spouse or spousal equivalent) in each of the two most recent years, with a reasonable expectation of the same income level in the current year.
• Any corporation, partnership, LLC, business trust, or 501(c)(3) charitable organization with total assets over $5 million, not formed specifically to acquire the securities offered.
• Any trust with total assets over $5 million, not formed specifically to acquire the securities offered, whose purchase is directed by a sophisticated person.
• Any entity in which all equity owners are accredited investors.
• Any other entity owning investments of more than $5 million, not formed specifically to acquire the securities offered.
• Any natural person in good standing with specific certifications, designations, or credentials. Those exams would include having passed the Series 7, the general representative exam, the Series 65, the investment advisor exam, or the Series 82 private securities offerings representative. These certifications and designations are designated by the SEC.

Advertising under Reg-D can be a little confusing, as there are 2 rules within it. 506(b) and 506(c). If the Reg-D is filed under 506(b), that is where we have at most 35 non-accredited investors, the most common way, and there can be no general advertising of the securities offering. 506(c), on the other hand, eliminated the non-accredited investors. To file under Reg-D 506(c), there can be 0 non-accredited investors, only accredited investors, but in that case, there can be general advertising, provided the issuer takes reasonable steps to verify that every purchaser really is an accredited investor, such as reviewing the purchaser’s tax forms or account statements, or getting written confirmation from their broker-dealer, investment adviser, attorney, or CPA.

Private placements, including Reg-D private placements, are not for immediate resale. Under Rule 144, there is a holding period before the buyer can resell the restricted, private offering security without registration: 6 months for issuers current with their SEC reporting requirements, and 12 months for non-reporting issuers. Usually there will be a document signed by participants in the Reg-D offering, that they will not sell the securities until that holding period is met or until they are registered.

Regulation S

This is an offering exemption for companies, US or foreign, that are issuing securities overseas. These are not expected to be sold in the United States. The company can issue any type of security, in any quantity they wish, outside the country, without filing any documentation with the SEC. They will of course, have to follow all of the laws of the country they are in fact issuing the securities in. To qualify the transaction must be executed offshore. An offshore transaction is one where no offer has been made to persons in the US, and at the time the buy order was placed, the buyer was outside the US, or the transaction is entirely executed through facilities of a designated offshore securities market or exchange.

At the time of the offering, a Reg-S offering can only be offered and sold to non-US persons offshore; US persons cannot purchase directly into the offering. The securities also carry a restricted period during which they cannot flow back into the US; after that period, normal resale rules apply.

Private investments in public equity (PIPE)

This is when private investors, often hedge funds and similar, directly purchases shares from the issuer, without going through a public offering, without going through exchanges. Directly purchasing shares from the issuer, at a discount from current market price, for several reasons. It helps encourage the speed, if you give the buy a discount. It helps offset the dilution caused by the additional shares, and the fact that if they need to use a PIPE, the issuer likely is in strong need of the money, and has few ways to raise it. These are used to very quickly raise capital for a company.