We run into offers and sales constantly in everyday life. Ads show up on social media, in search results, and in plenty of other places. For the Series 63 exam, you’ll want to know what an offer and a sale of a security mean legally. The definitions can feel obvious until an unusual situation comes up.
For example: what if you buy a new Ford truck and the dealership gives you 100 shares of Ford stock “for free”? Is that a sale of a security?
Let’s start with the legal definitions.
In plain English:
The basic idea is straightforward. Where it gets tricky is that the Uniform Securities Act (USA) specifically:
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 with the purchase of another item. If the 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 built into the overall purchase.
Back to the earlier example: if a Ford dealership advertises that it will give customers 100 shares of Ford common stock for free with the purchase of a new Ford truck, that advertisement is legally an offer of securities. If a customer buys the truck and receives the shares, a sale of securities has occurred.
Why does this matter? Only registered financial professionals can offer securities to the public. For this to happen legally, the dealership would need to be registered and regulated as a broker-dealer, and any employee involved would be considered an agent. That registration, regulation, and the related fees would significantly increase the cost of running the dealership. This is why you don’t see publicly traded auto companies offering their stock (or other securities) as customer “bonuses.”
Gift of assessable stock
You’ve probably never heard of assessable stock because it hasn’t been used for decades. Even so, it’s covered in the USA, so it can still appear on the exam.
Assessable stock is stock that was originally issued at a discount to its “face value” (the value assigned by the issuer), with the expectation that the issuer would collect the difference later.
Example:
Often, investors weren’t given a specific date for when that additional payment would be due.
Now, compare two types of gifts:
Using the ABC example: if you gift the assessable stock before the issuer collects the $20 per share, the issuer’s request for payment would go to the new owner (the person you gifted the stock to).
So under the USA:
For exam purposes, keep these points straight:
Warrants, rights, derivatives, and convertibles
To understand how the USA treats these, it helps to look at the language directly:
“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.”
Before applying that rule, here are the basics of the following terms (which you may already know from other 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 many details about these products for the Series 63. The key characteristic to remember is this: each one can give the holder the opportunity to obtain another security.
Because of that, the USA treats an offer or sale involving these securities as also involving the underlying security.
Example: a WMT call option is a security. If a financial professional solicits an investor to buy it, that’s an offer and sale of the WMT call option. Under the USA’s rule, it’s also treated as an offer (and potentially a future sale) of the underlying security - WMT stock.
It’s just as important to know the situations 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.
A common example is a margin account. These brokerage accounts allow an investor to borrow money for investment purposes (known as leveraging). Broker-dealers that offer margin require customers to pledge the securities in the account as collateral for the loan.
As with any secured (collateralized) loan, if the loan can’t be repaid, the collateral can become the lender’s property (the broker-dealer in this example). Even though a sale may occur later if the lender takes the collateral, the act of pledging securities for a loan is not an offer or sale.
Stock dividends
Stock issuers can pay dividends. The most common dividend is a cash dividend, but issuers can also declare stock dividends.
A stock dividend gives current stockholders additional shares. Even though that sounds like a gain, the share price typically drops proportionately. So the investor ends up with:
resulting in no change to the overall value of the position.
Because stock dividends are essentially a wash in value, the USA does not treat them as an offer or sale of securities.
Corporate actions
Corporations can change structure over time in several ways:
In many of these situations, a new security is created. For example, when eBay spun off PayPal, eBay investors received one new share of PayPal for every share of eBay they owned.
The USA states that a corporate action resulting in a new security is not considered an offer or sale of a security.
You don’t need the details of any of the following for the exam, but these are the types of corporate actions that could be referenced (none of which are offers or sales):
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