Exempt transactions let a non-exempt security be offered or sold without registration when the sale happens in a specific, legally defined way.
A non-exempt security is a security that doesn’t have an exemption based solely on what it is. Most securities (including most stocks) are non-exempt.
These are the exempt transactions covered in the USA:
We discussed Regulation D in a previous chapter, which is the federal version of a private placement. A private placement is a non-public sale of a security to a limited group of investors.
The USA (state) has its own private placement exemption that can apply when the transaction is intrastate (within one state).
A security offered to no more than 10 non-institutional (retail) investors in the previous 12 months is eligible for the private placement exemption. In addition:
*Commissions can be collected from private placement sales to institutional investors.
Example: A local business in your state wants to raise capital by selling stock while avoiding state registration of the security. The company offers the security to you plus 9 other retail investors, and no commission is taken. You buy the stock for investment purposes and now hold an unregistered, non-exempt security. The issuer was able to sell the stock without registering it because the sale qualified as an exempt transaction.
You now hold a restricted security that can’t be sold in the public markets until it’s registered. That doesn’t mean you can’t sell it at all. If your resale qualifies for an exempt transaction (often one of the exemptions below), you can sell the security without registration.
As per the USA:
Any isolated non-issuer transaction, whether effected through a broker-dealer or not [is considered an exempt transaction]
The USA doesn’t give a lot of detail here, so it helps to unpack the terms:
In many cases, an isolated non-issuer transaction happens between family members, friends, or colleagues.
Example: In the private placement example above, you bought stock from a local business (an issuer transaction). Later, you sell that unregistered, non-exempt stock to a friend. If this resale is truly infrequent (not part of a pattern of repeated sales), it can qualify as an isolated non-issuer transaction, allowing you to sell without registration.
If you want to sell your non-exempt, unregistered stock but can’t find a buyer on your own, you can contact your broker-dealer for help - as long as the order is unsolicited.
Key point: the broker-dealer can’t recommend the transaction in any way. The broker-dealer may also ask you to sign a non-solicitation letter (some state administrators require this). The letter states that you’re choosing to sell without being solicited or pressured by the broker-dealer.
A fiduciary is a person who is legally responsible for managing someone else’s assets. The USA specifically identifies these fiduciaries as qualifying for exempt transactions:
Here’s how each can create an exempt transaction involving a non-exempt, unregistered security:
Some loans are secured (collateralized). For example, a mortgage is secured by the home. If the borrower doesn’t pay, the lender can take the collateral.
A borrower can also pledge a non-exempt, unregistered security as collateral. If the loan goes unpaid, the lender can sell the security under this exemption to recover the loaned funds.
The USA may describe these as bona fide loans, meaning legitimate loans. This wouldn’t apply if someone pledged a non-exempt, unregistered security as collateral while intending to default immediately, using the “loan” as a pretext to sell the security.
Many public offerings begin with a sale from the issuer to underwriters. An underwriter is a financial firm that sells securities on behalf of issuers.
In a previous chapter, we discussed how Morgan Stanley and Goldman Sachs acted as co-lead underwriters on the AirBnB initial public offering (IPO). Before Morgan Stanley and Goldman Sachs sold AirBnB stock to the public, they first purchased the stock from Airbnb.
The sale of a security from an issuer to its underwriter(s) does not require the security to be registered. However, the later sale from the underwriter to the general public does require registration (unless another exemption applies).
Throughout this material, we’ve seen that institutional investors don’t receive many of the same protections required for retail investors. For that reason, the USA allows sales to many institutional investors to occur without registration.
The following institutions are specifically mentioned:
A pre-organization certificate is a pledge by an investor to purchase a security in the future from an organization that has not yet been formed. Companies use them to line up capital (money) before the business is officially formed.
This exemption applies as long as:
Let’s summarize the key distinction from this chapter and the previous one:
It’s common to see exam questions testing that difference. For example:
All of the following are exempt transactions according to the Uniform Securities Act, EXCEPT:
A) An offer of securities to 8 retail investors in a 12-month period
B) An offer of a Treasury bond to hundreds of retail investors
C) An offer of a pre-organization certificate to 9 potential subscribers
D) An offer of common stock to an institutional investor
Can you figure out the answer?
Answer: B - An offer of a Treasury bond to hundreds of retail investors
A Treasury bond is an exempt security, meaning it avoids registration in all circumstances. Selling it to hundreds of retail investors doesn’t make it an exempt transaction. The security isn’t required to be registered, but that’s because of what it is - not because of how it’s being sold.
The other answers describe exemptions based on how the transaction is conducted:
Answer choice A refers to a private placement. An exempt transaction exists as long as an offering of securities is limited to no more than 10 retail investors in a 12-month period, no commission is collected from retail investors, and those retail investors are purchasing the security for investment purposes.
Answer choice C refers to a pre-organization certificate. An exempt transaction exists as long as an offering of pre-organization certificates is limited to no more than 10 subscribers and no payment or commission is collected.
Answer choice D refers to a sale of securities to an institutional investor, which is an exempt transaction.
Many test takers remember exempt securities as nouns, while exempt transactions are verbs. An exempt security is exempt based on what it is (a noun), while an exempt transaction provides an exemption based on an action (a verb).
In the exempt securities section above, we learned how non-profit and employee benefit security exemptions can be removed by the state administrator if fraud or another “sketchy” situation is suspected. This same concept applies to all the exempt transactions discussed above.
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