Now that you understand the federal registration process for securities, the next step is knowing when an issuer can avoid it. Registration is time-consuming and expensive, so many persons try to use an exemption when one is available. The Securities Act of 1933 provides exemptions for certain issuers, issues, and transactions. When an exemption exists, it’s typically because the investing public is considered to face limited risk.
There are two general types of exemptions:
Exempt securities are always exempt from registration, regardless of the situation or type of transaction. That’s a major advantage for issuers raising capital because it avoids the time and cost of registration.
These are the exempt securities covered in this section:
Government securities
US Government and all municipal (state and local government) securities are exempt from registration. These are the most commonly cited government securities:
Insurance company products
Insurance companies are regulated under their own laws, which aren’t the focus here. Most insurance products are generally exempt, but there’s one key exception: insurance products with a variable component are not exempt.
You’ll learn more about variable annuities in the annuities chapter. Variable annuities are the primary non-exempt insurance product to remember.
Technically, most insurance products do not meet the definition of a security, which means they’re excluded from registration.
Bank securities
Banks are also subject to their own laws, so their investment products generally avoid registration. Most bank securities are exempt, but bank holding company securities are not.
Bank holding companies are organizations that own banks and may also own other types of companies. Bank of America is an example: in addition to banking services, it owns other companies like Merrill Lynch. Because of that structure, Bank of America securities (including its common stock) are not exempt from registration.
By contrast, a security issued by a bank that is focused only on banking activities is exempt.
Non-profit securities
Securities issued by non-profits - including charities, religious organizations, and social advocacy groups - are exempt. For example, if the Red Cross wanted to issue a bond, it could do so without registering it with the SEC.
Commercial paper and banker’s acceptances
As you learned in the corporate debt chapter, commercial paper is a short-term, zero coupon debt instrument. It’s sold at a discount and matures at par.
The Securities Act of 1933 specifies that any security with a maturity of 270 days or less is exempt from registration. Because of this rule, commercial paper is virtually always issued with a maximum maturity of 270 days.
The same concept applies to banker’s acceptances, which are short-term financing vehicles used by importers and exporters.
Railroad ETCs
Equipment trust certificates (ETCs) issued specifically by railroad companies are exempt. Common carriers like railroads are already regulated under other laws for their financial activities, so the Securities Act of 1933 doesn’t cover them.
Even if the issuer and the security itself are not exempt, an exemption may apply based on how the security is sold. This section covers two ways a non-exempt security can be offered and still qualify for an exemption:
Regulation D
Regulation D offerings are also called private placements. They involve selling securities to a private audience rather than the general public. Since the Securities Act of 1933 is designed to protect the general investing public, the rules are relaxed when the offering is limited to a smaller, non-public group. If an issuer sells a security under Regulation D, it can avoid registration.
Many growing companies use private placements early on and later move to an IPO. The reason is straightforward: private placements let an issuer raise capital without the time and cost of registration. In an issuer’s ideal scenario, it would raise all needed capital through private placements. In practice, these offerings are limited to accredited (wealthy and/or sophisticated) investors and a small number of non-accredited investors.
For example, Airbnb participated in multiple private placements starting in 2008. The company later completed an IPO in late 2020 when it sought a large amount of capital ($3.5 billion) that likely couldn’t be raised solely from accredited investors. Many companies follow this cycle:
Regulation D allows unregistered, non-exempt securities to be sold to an unlimited number of accredited investors. As a result, millionaires, billionaires, and institutions make up most private placement investors. An investor is accredited if they meet any of the following characteristics:
Accredited investors
*For an institution to qualify as an accredited investor, it cannot be formed solely for the purpose of purchasing securities in a private placement.
Even if an investor isn’t accredited, they may still be able to participate. Regulation D allows up to 35 non-accredited investors in a private placement. Non-accredited investors must sign documents acknowledging the risks, especially because the issuer avoids registration and won’t provide a prospectus.
Instead, investors receive disclosures in an offering memorandum, which is similar to a prospectus but typically provides less detail.
Rule 147
Rule 147 allows issuers offering securities intrastate (within one state only) to avoid federal registration. Federal agencies like the SEC generally regulate offerings made interstate (across state lines). If an issuer sells all of its securities only in Colorado (or any other single state), it can avoid SEC registration.
Rule 147 comes with several requirements. The issuer must be operating “primarily” in one state, and its headquarters must be located in the state where the offering occurs. Under the “80% rule,” a company is considered primarily operating in one state if:
Investors must be residents of the state. They must also wait 6 months before selling any Rule 147 securities to a non-resident. However, they may sell the securities immediately to another resident of the state.
Although there’s no SEC oversight for Rule 147 offerings, state registration typically applies. In particular, intrastate securities are usually subject to state registration by qualification (more on this later in the unit).
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