We run into offers and sales all the time in everyday life. Ads show up constantly - on social media, in search results, and everywhere in between. For the Series 65 exam, though, you’ll need the legal definition of an offer and a sale of a security. The definitions can feel obvious until you hit an unusual situation.
For example, what if you bought a new Ford truck and the dealership gave 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) explicitly includes certain situations as offers/sales, and explicitly excludes others. Those special cases show up on exams.
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 have a separate price tag. The USA treats the security’s cost as being included in the overall purchase.
Back to the Ford example: if a 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 accepts the deal, a sale of securities has occurred.
Why does this matter? Only properly registered financial professionals can offer securities to the public. For the dealership to do this legally:
That registration and regulation would add significant cost and complexity to the dealership’s business.
Gift of assessable stock
You’ve probably never heard of assessable stock because it hasn’t been used for decades. It’s still covered in the USA, so it can still appear on the exam.
Assessable stock is stock sold initially at a discount to its “face value” (the value assigned by the issuer), with the expectation that the issuer will later collect the difference.
Example:
Often, there was no clear date for when that additional $20 would be due.
Now compare two gifts:
Even though no money changes hands at the time of the gift, the USA treats the gift of assessable stock as an offer and sale:
For exam purposes, here’s what to remember:
Warrants, rights, derivatives, and convertibles
To understand how the USA treats these, it helps to use the USA’s own language:
“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, let’s quickly review what these instruments are.
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 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.
The key USA rule is this: when you offer or sell one of these instruments, the USA treats it as also involving an offer (and potentially a future sale) of the underlying security.
Example: a WMT call option is a security itself. If a financial professional solicits and completes the transaction, that’s an offer and sale of the 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 when an offer or sale is not being made. There are three situations to track:
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.
If the loan can’t be repaid, the collateral may become the lender’s property, and a sale may occur at that point. But the act of pledging securities for a loan is not, by itself, an offer or sale.
Stock dividends
Issuers can pay dividends to stockholders. 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 you end up with more shares, the share price typically drops proportionately. So if a stockholder starts with $10,000 of stock, they’ll generally end with $10,000 of stock after the stock dividend - more shares, but at a proportionately lower price.
Because stock dividends don’t change the investor’s overall position value in this way, the USA does not treat them as an offer or sale of securities.
Corporate actions
Corporations can change structure in several ways over time:
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 corporate actions resulting in a new security are not considered an offer or sale of a security.
You don’t need the details of each item below, but these are the corporate actions that could be referenced on the exam (none of which are offers or sales):
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