We run into offers and sales all the time in everyday life. Most people also see a steady stream of ads - especially on social media and in search results. For the Series 66 exam, you’ll want to know the legal meaning of an offer and a sale of a security. The definitions can feel obvious, but securities law is very specific - especially in unusual situations.
For example, what if you bought a new Ford truck and the dealership gave you 100 shares of Ford stock “for free”? Would that count as a sale of a security?
Let’s start with the legal definitions.
In plain English:
The basic idea is straightforward. Where students get tripped up 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 have a separate price tag. The USA assumes the cost of the security is built into 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, it would need to be registered and regulated as a broker-dealer, and any employee involved would be an agent. Registration, supervision, and compliance costs would significantly increase the cost of operating the dealership. That’s why - even though several automobile companies are publicly traded (Ford, Tesla, GM, Honda) - you don’t see them offering 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 show up on the exam.
Assessable stock is stock that was originally sold at a discount to its “face value” (the value assigned by the issuer), with the expectation that the issuer would later bill the shareholder for the difference.
Example:
Often, there was no clear date for when that future bill would arrive.
Now compare two gifts:
Here’s the key exam takeaway:
Warrants, rights, derivatives, and convertibles
To understand how the USA treats these, it helps to look at the statute’s wording:
“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:
*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 the 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. This means current shareholders get the first opportunity to buy new shares in follow-on offerings (sometimes called 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 investors have little time to decide whether to exercise (usually 60-90 days).
Derivatives: a general term for investments whose value is 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 buy a WMT (Walmart) $140 call, you’ve purchased a contract that gives 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 can 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, and both are 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 to common stock changes how the investor can earn a return: fixed-income investments pay the same amount of income (hence the name), while common stock offers capital appreciation (buy low, sell high) potential. Common stock is more aggressive, so the investor receives a riskier investment if a conversion occurs.
For USA purposes, the key point is this: these instruments can give the holder the right to obtain another security. So when someone offers or sells a warrant, right, derivative, or convertible, the USA treats that transaction as also involving an offer (and potentially a future sale) of 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 option. Under the USA rule above, 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, the collateral becomes the lender’s property (the broker-dealer in this example) if the loan can’t be repaid.
Even though a sale may occur later if the lender takes ownership of the collateral, the act of pledging securities in exchange for a loan does not constitute 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 that sounds like a gain, the share price typically drops proportionately. If a stockholder starts with $10,000 of stock, they’ll still have $10,000 of stock after the stock dividend - just spread across more shares at a lower price per share.
Because stock dividends don’t change the investor’s overall 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 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 types of corporate actions that could be referenced on the exam (none of which are offers or sales):
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