We discussed exempt securities in the previous chapter. Exempt securities avoid registration requirements based on what they are.
Now we’ll look at exempt transactions. These exemptions allow non-exempt securities to be offered or sold without registration because of how the transaction is conducted.
A non-exempt security is a security that doesn’t qualify for an exemption based solely on its type. Most securities - including the vast majority of stocks - are non-exempt.
These are the exempt transactions covered in the Uniform Securities Act (USA):
We discussed Regulation D in a previous chapter, which is the federal version of a private placement. A private placement is a non-public sale of a security to a small group of investors.
The USA (state) has its own private placement exemption that applies when the transaction is intrastate (in one state only).
A security offered to no more than 10 non-institutional (retail) investors in the previous 12 months is eligible for the private placement exemption. In addition:
Commissions can be collected from private placement sales to institutional investors.*
Assume a local business in your state wants to raise capital by selling stock while avoiding state registration of the security. The company offers the security to you plus 9 other retail investors and takes no commission. You purchase the stock for investment purposes and now hold an unregistered, non-exempt security. The issuer was able to sell the stock without registering it because of the way it was sold (an exempt transaction).
You now hold a restricted security that can’t be sold in the public markets until it’s registered. That doesn’t mean you can’t sell it at all. If you can rely on an exempt transaction yourself (often one of the exemptions below), you may be able to sell the security without registration.
As per the USA:
Any isolated non-issuer transaction, whether effected through a broker-dealer or not [is considered an exempt transaction]
The USA doesn’t give a precise definition here, so it helps to unpack the terms:
In many cases, an isolated non-issuer transaction occurs between family members, friends, or colleagues.
Go back to the earlier example where you purchased stock from a local business in a private placement. You could sell that non-exempt, unregistered stock to a friend and rely on this exemption, as long as the sale is truly isolated (not frequent or repeated). That allows you to sell the security without it being registered.
Suppose you want to sell your non-exempt, unregistered stock but can’t find a friend or family member who wants it. You could contact your broker-dealer and ask for help selling the security, as long as the transaction is unsolicited.
That means:
The non-solicitation letter states that you’re attempting to sell the security without coercion or recommendation from the broker-dealer.
A fiduciary is a person placed in charge of managing another person’s assets or belongings. The USA specifically identifies these fiduciaries as qualifying for exempt transactions:
An estate executor or administrator is appointed to oversee the estate of a deceased person. If the deceased person owned a non-exempt, unregistered security, the executor or administrator could sell it under this exemption.
Sheriffs and marshals are law enforcement officers who may take possession of assets of those subject to criminal prosecution. If a judge orders a convicted criminal to pay a fine to the state, a non-exempt, unregistered security could be liquidated under this exemption.
A receiver is appointed by a judge to take temporary possession of assets while a lawsuit is pending. If the court requires the sale of a non-exempt, unregistered security, the receiver can complete the transaction under this exemption.
A trustee may be appointed to oversee a person’s bankruptcy. If the bankruptcy court orders liquidation of the bankrupt person’s assets, a non-exempt, unregistered security may be included. This exemption allows the trustee to sell the security without registering it.
Guardians and conservators are court-appointed fiduciaries who oversee the assets of a person who can’t do so themselves, typically due to mental illness or incapacitation. If that person owns a non-exempt, unregistered security and the guardian or conservator needs to sell it, they can rely on this exemption.
Some loans are secured (collateralized). For example, a mortgage is a secured loan: if the homeowner can’t make the required payments, the lender can repossess the property (the collateral).
A person could also pledge a non-exempt, unregistered security as collateral for a loan. If the loan isn’t repaid, the lender can sell the security under this exemption to recover the money.
The USA sometimes describes these as bona fide loans, meaning legitimate loans. This would not apply if someone pledged a non-exempt, unregistered security as collateral with the immediate intention of defaulting. In that situation, the “loan” is really being used as a way to sell the security while improperly claiming the exemption.
Most public offerings begin with a sale from the issuer to underwriters. An underwriter is a financial firm that sells securities on behalf of issuers.
In a previous chapter, we discussed how Morgan Stanley and Goldman Sachs acted as co-lead underwriters on the AirBnB initial public offering (IPO). Before Morgan Stanley and Goldman Sachs sold AirBnB stock to the public, they first purchased the stock from AirBnB.
The sale of a security from an issuer to its underwriter(s) does not require the security to be registered. However, the subsequent sale from the underwriter to the general public does require registration (unless another exemption applies).
As we’ve seen throughout this material, institutional investors don’t require many of the same protections offered to retail investors. For that reason, the USA allows sales to many institutional investors to occur without registration of the security. The following institutions are specifically mentioned:
A pre-organization certificate is a pledge by an investor to purchase a security in the future from an organization that has not yet been formed. Companies use them to help ensure access to capital once the company is officially formed.
As long as pre-organization certificates are offered to no more than 10 potential subscribers and no payment or commission is received, they avoid registration requirements under this exemption.
Let’s summarize the key distinction from this chapter and the previous one:
An exam question may test this difference. For example:
All of the following are exempt transactions according to the Uniform Securities Act, EXCEPT:
A) An offer of securities to 8 retail investors in a 12 month period
B) An offer of a Treasury bond to hundreds of retail investors
C) An offer of a pre-organization certificate to 9 potential subscribers
D) An offer of common stock to an institutional investor
Can you figure out the answer?
Answer: B - An offer of a Treasury bond to hundreds of retail investors
A Treasury bond is an exempt security that avoids registration in all circumstances. Selling it to hundreds of retail investors does not need to qualify as an exempt transaction. The security isn’t required to be registered, but that’s because of what it is - not because of how it’s being sold.
The other answers describe exemptions based on how the transaction is performed.
Answer choice A refers to a private placement. An exempt transaction exists as long as an offering of securities is limited to no more than 10 retail investors in a 12 month period, no commission is collected from retail investors, and those retail investors are purchasing the security for investment purposes.
Answer choice C refers to a pre-organization certificate. An exempt transaction exists as long as an offering of pre-organization certificates is limited to no more than 10 subscribers and no payment or commission is collected.
Answer choice D refers to a sale of securities to an institutional investor, which is an exempt transaction.
Many test takers remember exempt securities as nouns, while exempt transactions are verbs. An exempt security is exempt based on what it is (a noun), while an exempt transaction provides an exemption based on an action (a verb).
In the previous chapter, we learned how non-profit and employee benefit security exemptions can be removed by the state administrator if fraud or another “sketchy” situation is suspected. This same concept applies to all the exempt transactions discussed above.
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