We encounter numerous offers and take part in sales in regular, everyday life. In fact, most of us are inundated with ads on a daily basis, especially on social media or even on a simple Google search. For purposes of the Series 63 exam, it’s important we understand what an offer and a sale (of a security) legally is. While it might seem obvious, the law is nitpicky, especially when a unique situation arises. For example, what if you bought a new Ford Truck and the dealership gave you 100 shares of Ford stock for free? Would it be considered a sale of a security?
Let’s start out with the legal definition of both:
In plain English, an offer is any attempt to sell a security to or buy a security from an investor. A sale occurs if that offer is accepted by the customer. Neither term is terribly complicated. However, there are unique circumstances the Uniform Securities Act (USA) specifically calls out as offers and sales. Additionally, there are some scenarios the USA specifically excludes as offers and sales. Let’s go through both.
The three unique circumstances the USA specifically defines as offers and/or sales are:
Bonus offer of securities
An offer of securities exists when a security is offered as a “free” bonus when purchasing another item. If a customer accepts the “free” bonus, a sale of securities occurs. It doesn’t matter that the security doesn’t cost anything extra. The USA assumes the cost of the security is wrapped up in the overall purchase.
Let’s go back to the first example described in this section - a Ford dealership advertises they’ll give customers 100 shares of Ford common stock for free with the purchase of a new Ford truck. Legally speaking, the advertisement would be considered an offer of securities, and a securities sale would occur if a customer accepted the offer.
Why is this important? Remember, only registered financial professionals can offer securities to the public. For this to occur, the dealership must be registered and regulated as a broker-dealer, and any employee engaged in the process would be considered an agent. Being subject to securities laws and registration fees would significantly increase the cost of running the dealership’s business. Although there are several publicly traded automobile companies (Ford, Tesla, GM, Honda), you won’t find any of them offering their stock (or any of their securities) to customers because of this rule.
Gift of assessable stock
You’ve probably never heard of assessable stock because it hasn’t been in existence for decades. Regardless, it’s covered in the USA, and therefore you could see exam questions on this defunct security.
So, what is assessable stock? It’s stock that’s initially offered by the issuer at a discount to the “face value” (what the issuer valued the shares at), with the expectation the issuer would ask for the difference later. For example, let’s assume ABC Company (the issuer) assigns a $50 face value to their stock, but then issues the security for $30 per share. When investors purchase the stock, they gain ownership in ABC Company, but they also owe the company $20 per share at some point in the future. Oftentimes, investors were not provided a date for the future invoice.
One more thing - what’s a gift? Good news… a gift is a gift; there’s no complicated legal definition to worry about. If I were to give you non-assessable stock (basically normal stock) as a friendly gesture, I’m handing ownership of that stock to you for nothing in return. This would not constitute an offer or sale of securities. I’m simply being nice!
But, what if I were to gift you assessable stock? Going back to our example, let’s say I purchase that assessable stock, and I know there’s a $20 per share bill I’ll receive in the future from the issuer. Before I get that invoice, I give you the stock for free. Now, that request would be sent to you (as you’re now the current stockholder) whenever the issuer decided they wanted their money.
Although there was no transfer of money during the gift, the USA interprets the gift as an offer and sale. When I offered the gift to you, I made an offer of securities. When you accepted the gift, a sale of securities occurred. In order to gift assessable stock regularly to the public, I’d have to be properly registered and regulated.
It’s always tough to conceptualize something that’s not in existence anymore, but here’s all you need to know for exam purposes:
Warrants, rights, derivatives, and convertibles
To best understand this topic, let’s quote a specific passage of the USA:
“Every sale or offer of a warrant or right to purchase or subscribe to another security of the same or another issuer, as well as every sale or offer of a security which gives the holder a present or future right or privilege to convert into another security of the same or another issuer, is considered to include an offer of the other security.”
We’ll first need to touch base on the basics of the following, which you already may know from previous licensing exams:
*The depictions of these are not typically tested on the exam; most of the following information provided is for context
Warrants: issued as a “sweetener” with the sale of another security, they provide the right to buy an issuer’s stock at a fixed price. For example, an issuer facing difficulties selling another security (like a bond) may attach a warrant to its sale to increase its marketability. Warrants are usually issued without intrinsic (inherent; immediate) value. For example, a warrant may provide the right to buy stock at $60 when the market price is $50. Initially, it makes no sense to exercise a warrant, but the exercise price ($60 in this example) stays fixed over long periods of time (generally 5+ years). If the market price rises above $60 before the warrant expires, it becomes valuable.
Rights: issued to fulfill an issuer’s obligation to provide their shareholders the ‘preemptive right’ to buy any new shares issued. Meaning, current shareholders have the first right to buy any new shares offered by the issuer in follow-on offerings, sometimes referred to as additional offerings. When companies go through their initial offerings (e.g. IPOs), many do not sell every possible share, allowing them to raise more capital (money) later. If the company decides to sell more shares in the future, it must give its current shareholders the first right to buy those new shares. Rights are issued with intrinsic value (allowing a purchase of stock at a price lower than the market price), but little time for the investor to decide if they’ll exercise (usually 60-90 days).
Derivatives: a general term that references any investment tied to the performance of something else. For example, a call option is a type of derivative that allows an investor to lock in a purchase price of a particular stock. If you were to buy a WMT (Walmart) $140 call, you’ve purchased a contract that provides you the right to buy 100 WMT shares (per option contract) at $140 per share, regardless of how high the market price rises. If WMT stock rises above $140, the call becomes valuable and will be exercised. Options don’t last forever, and most expire within 9 months of issuance.
Convertibles: preferred stock and bonds are the most common convertible securities, which are both fixed income securities. Normally, investors in these securities collect semi-annual payments. If the security is convertible, it allows the investor to convert the investment into common stock of the same issuer. Converting these securities to common stock provides the investor with a change in how they can make a return. Fixed-income investments pay the same amount of income (hence the name), while common stock provides capital appreciation (buy low, sell high) potential. Common stock is more aggressive, and therefore a riskier investment is received if a conversion occurs.
You don’t need to know much about the specifics of these securities for the Series 63, but you should keep track of one characteristic of convertible securities: they all offer the opportunity to obtain another security. While an advertisement or transaction relating to any of these securities is definitely considered an offer and/or sale, the USA makes it clear it’s also considered an offer and/or sale of the underlying security.
For example, let’s go back to the WMT call option. Options are securities themselves; a financial professional that entices an investor to purchase it has officially performed an offer and sale of the WMT call option. But, they’ve also made an offer, and potentially a future sale of the underlying security - WMT stock.
It’s equally important to know the unique circumstances where an offer or sale is not being made. There are three to keep track of:
Bona fide pledges or loans
A security can be pledged as collateral for a loan without being considered an offer or sale. For example, you may already know about margin accounts. These are brokerage accounts that allow the investor to borrow money for investment purposes (known as leveraging). Broker-dealers that offer them require their customers to pledge the securities in the account as collateral for those loans. As with any other secured (collateralized) loan, the collateral becomes the property of the lender (the broker-dealer in this example) if the loan cannot be repaid.
Although a sale may occur if the collateral becomes the property of the lender, the act of pledging securities in return for a loan does not constitute an offer or sale.
Stock dividends
Issuers of stock can pay their investors dividends. The most common type of dividend is a cash dividend (essentially sharing profits with stockholders), but issuers can also declare stock dividends. Stock dividends result in current stockholders receiving more shares of the issuer’s stock. Although this sounds like a good deal, it usually doesn’t mean much for an investor. They obtain new shares, but the share price drops proportionately. If a stockholder starts with $10,000 of stock, they’ll end with $10,000 of stock after the stock dividend. They’ll own more shares, but at a proportionately lower price, resulting in no change to the overall value of their stock position.
In the end, stock dividends are a wash for investors, so the USA doesn’t view them as an offer or sale of securities.
Corporate actions
There are many ways a corporation can evolve over time. Mergers occur when one company is folded into another (e.g. 20th Century Fox becoming a part of Disney). Consolidations occur when two companies become a new company (e.g. Exxon and Mobil consolidating into new company Exxon Mobil). Spinoffs occur when a larger company spins off one of its own departments as its own standalone company (e.g. eBay’s spinoff of PayPal).
In most of these circumstances, a new security is created. When eBay performed the spinoff of PayPal, eBay investors received one new share of PayPal for every share of eBay they owned. The USA states any corporate action resulting in a new security is not considered an offer or sale of a security.
You don’t need to know the specifics of any of the following, but these are the types of corporate actions that could be referenced on the exam (none of which are offers or sales):
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