In the previous two chapters, we discussed how a security can be registered with the state administrator. This chapter covers the various exemptions that allow issuers and other interested parties to avoid the securities registration process.
A security may avoid registration if:
An exempt security avoids registration based solely on what it is (the type of security), not on how or to whom it’s sold. The Uniform Securities Act (USA) explicitly lists the following as securities exempt from state registration:
The descriptions below begin with direct quotes from the USA.
Any security (including a revenue obligation) issued or guaranteed by the United States, any state, any political subdivision of a state, or any agency or corporate or other instrumentality of one or more of the foregoing
Any security issued or guaranteed by a US government entity is exempt. There are three broad layers of government securities to keep in mind:
Any security issued or guaranteed by Canada, any Canadian province, any political subdivision of any such province, any agency or corporate or other instrumentality of one or more of the foregoing
Canadian government securities are exempt in the same way as US government securities. This includes federal (national), provincial, city, and other local government securities.
Any other foreign government with which the United States currently maintains diplomatic relations, if the security is recognized as a valid obligation by the issuer or guarantor
For foreign governments other than Canada, the exemption is limited to national (federal) government securities.
For example, a bond issued by the French government would be exempt, but a bond issued by the city of Paris would not be exempt.
Two conditions must be met:
Any security issued by and representing an interest in or a debt of, or guaranteed by, any bank organized under the laws of the United States, or any bank, savings institution, or trust company organized and supervised under the laws of any state
Any security issued by and representing an interest in or a debt of, or guaranteed by, any federal savings and loan association, or any building and loan or similar association organized under the laws of any state and authorized to do business in this State
Any security issued or guaranteed by any federal credit union or any credit union, industrial loan association, or similar association organized and supervised under the laws of this state;
Bank securities are generally exempt. In other words, if the issuer is a qualifying bank (or bank-like institution), its securities are exempt from state registration.
A key detail is the difference between nationally regulated and state-regulated institutions:
Example: Suppose a bank is organized and regulated only in Kentucky. If it offers its securities in another state where it isn’t authorized to do business, the exemption wouldn’t apply there. A sale in Kentucky would be exempt.
Here are the “banking” entities that qualify for this exemption:
This exemption does not apply to bank holding companies, which we discussed in an earlier chapter.
Any security issued by and representing an interest in or a debt of, or guaranteed by, any insurance company organized under the laws of any state and authorized to do business in this state; [but this exemption does not apply to an annuity contract, investment contract, or similar security under which the promised payments are not fixed in dollars but are substantially dependent upon the investment results of a segregated fund or account invested in securities]
Insurance company securities are generally exempt, except for variable contracts.
These are the three non-exempt insurance company securities to know:
A practical shortcut: if an insurance product has the word “variable” in the name, it’s not exempt.
Also remember the authorization requirement: the insurance company must be authorized to do business in that state (the same idea we saw with banks).
Any security issued or guaranteed by any railroad, other common carrier, public utility, or holding company
The USA specifically mentions railroads because early versions of the Act were written when railroads were a major part of commerce. Securities issued by public utility companies (for example, a local electric provider) also fall under this exemption.
We previously discussed federal-covered securities, which are subject to notice filing in every state where they’re offered. While this topic can be confusing, the key point is that federal-covered securities may have limited filing requirements, but they’re exempt from full state registration.
As a reminder, the three categories of federal-covered securities are:
Any security issued by any person organized and operated not for private profit but exclusively for religious, educational, benevolent, charitable, fraternal, social, athletic, or reformatory purposes, or as a chamber of commerce or trade or professional association
Securities issued by many types of non-profits - including churches, universities, and charities - are exempt from registration.
However, the USA allows the state administrator to remove this exemption if fraud or other suspicious activity is suspected. This matters because the North American Securities Administrators Association (NASAA) has documented numerous instances of affinity fraud over the years.
A promissory note, draft, bill of exchange or bankers’ acceptance that evidences an obligation to pay cash within 9 months after the date of issuance, exclusive of days of grace, is issued in denominations of at least $50,000, and receives a rating in one of the 3 highest rating categories from a nationally recognized statistical rating organization; or a renewal of such an obligation that is likewise limited, or a guarantee of such an obligation or of a renewal;
Promissory notes - also called commercial paper - are short-term corporate debt obligations. They’re typically issued at a discount, pay no interest during the life of the security (zero coupon), and mature at par.
A promissory note is an exempt security if it meets all of these state-level conditions:
Organizations like Moody’s and S&P Global Ratings (formerly Standard & Poors) commonly provide ratings on these securities.
*As we discussed earlier, federal exemptions only require these securities to be 9 months (technically 270 days) or less to maturity. There is no federal minimum denomination or debt rating minimum requirement. Many test takers forget the additional state requirements, and the test writers know this. Be sure to be aware of the differences between the federal and state exemption.
Any investment contract issued in connection with an employees’ stock purchase, savings, pension, profit-sharing, or similar benefit plan
Many companies offer securities and other investment plans to employees without registering those offerings. A key reason this exemption exists is that these offerings aren’t available to the general public.
As with non-profit securities, the USA allows the state administrator to remove this exemption if fraud or other suspicious activity is suspected.
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