Now that you know the registration process, it’s important to know when an issuer can avoid it. Registering securities with the SEC can be lengthy and expensive.
To provide the documentation requested by the Securities and Exchange Commission (SEC), an issuer typically hires lawyers, accountants, and other professionals. During registration, these professionals help the issuer disclose detailed information about its background, financial condition, and future plans. The SEC also charges substantial filing fees.
Registration matters because it helps ensure the investing public has enough information to make informed decisions. However, the Securities Act of 1933 provides exemptions for certain issuers, issues, and transactions. When an exemption applies, it’s usually because the offering is considered to present limited risk to the investing public. There are two general types of exemptions:
Exempt securities are always exempt from registration, regardless of the situation or type of transaction. A key advantage of raising capital with these securities is that the issuer can avoid the time and cost of SEC registration.
These are the exempt securities we’ll cover in this section:
US Government and all municipal (state and local government) securities are exempt from registration. Regulators generally assume the government can be trusted to avoid fraud when offering securities to investors.
As a reminder, here are the most commonly cited government securities:
Insurance companies are regulated under their own laws. Most insurance company securities are exempt, but there’s an important exception: insurance products with a variable component are not exempt.
You’ll learn more about variable annuities in the Annuities chapter. For exam purposes, variable annuities are the primary non-exempt insurance product to remember.
Banks are also regulated under their own laws, so bank-issued securities are generally exempt. The key exception is bank holding company securities.
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 businesses such as Merrill Lynch. As a result, 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.
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.
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.
You also learned about banker’s acceptances, which are securities used to facilitate international trade.
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 and banker’s acceptances are virtually always issued with maximum maturities of 270 days.
Equipment trust certificates (ETCs) issued 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. In this section, we’ll cover three ways a non-exempt security can be offered and still qualify for an exemption:
Regulation A+ offerings are often called “small dollar” offerings. If a company issues up to $75 million of securities in a 12-month period, it can avoid registering the security with the SEC. While $75 million is a large amount in everyday terms, it’s relatively small in the broader capital markets. For context, Saudi Aramco raised $25 billion during its IPO in 2019.
When an issuer uses Regulation A+, it avoids filing a traditional registration statement and does not need to prepare a prospectus. However, investors still receive disclosure through an offering circular, which typically includes information about the issuer’s background and financial condition. The offering circular is less detailed than a prospectus, but it still provides meaningful information about the issuer and the offering. Issuers must file a copy of the offering circular with the SEC.
There are two tiers related to Regulation A+ offerings:
Tier 1 offering
Tier 2 offering
*Although Regulation A+ offerings avoid many of the rules and regulations typically imposed on public offerings, some regulator oversight still exists. This is why the SEC and the state administrator review some of these offerings. You don’t need to know the specifics, other than what type of review each offering is subject to.
**Purchase limits for investors only apply to Tier 2 offerings. If an investor does not qualify as accredited (see below), they cannot purchase more than 10% of their net worth or net income, whichever is greater.
Regulation D offerings are also known as “private placements.” These involve selling securities to a private audience rather than to 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 securities under Regulation D, it can avoid registration.
Many growing companies use private placements before eventually conducting initial public offerings (IPOs). Private placements let an issuer raise capital without the time and expense of registration. In practice, these offerings are primarily sold to accredited (wealthy and/or sophisticated) investors (defined below), plus a limited number of non-accredited investors. Issuers often rely on private placements until they need more capital than this investor base can provide.
For example, Airbnb took part in multiple private placements starting after its inception in 2008. Eventually, the company completed an IPO in late 2020 when it sought a large amount of capital ($3.5 billion) that it likely couldn’t raise 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, private placements are dominated by high-net-worth individuals and institutions. An investor is accredited if they meet any of the following criteria:
Accredited investors
*This is a recent update to the accredited investor definition. Congratulations - if you pass this exam, you’ll be considered an accredited investor!
**For an institution to qualify as an accredited investor, it cannot be formed solely for the purpose of purchasing securities in a private placement.
Investors who are not accredited may still be able to participate. Regulation D allows up to 35 non-accredited investors in a private placement. These investors must sign documents acknowledging that they understand the risks involved, including the reduced level of available information.
Because private placements avoid registration, investors won’t receive a prospectus. Instead, they receive disclosures in an offering memorandum, which is similar to a prospectus but less detailed.
Rule 147 allows issuers to avoid federal registration when they offer securities intrastate (within one state only). Federal regulators like the SEC generally focus on offerings that cross state lines. If an issuer sells all of its securities only within Colorado (or any other single state), it can avoid SEC registration.
Rule 147 includes several conditions. 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 reselling Rule 147 securities to a non-resident. However, they may resell immediately to another resident of the same state.
Although Rule 147 offerings avoid SEC oversight, states regulate their own financial markets through “blue sky” laws. State registration and related rules are defined under the Uniform Securities Act. The term ‘blue sky’ comes from an old saying that fraudsters would sell you the blue sky if they could.
The state-level equivalent of the SEC is the state administrator. Each state has its own securities administrator, typically an office responsible for protecting investors and enforcing the Uniform Securities Act. The goal is similar to the SEC’s: preventing fraud and manipulation in the securities markets.
Even if a security is sold in multiple states, it must be registered unless it qualifies for an exemption. Most of the exemptions discussed earlier apply at the state level as well.
There are three types of registration at the state level:
Registration by filing (notice filing)
Larger, well-established issuers often use registration by filing, which results in federal registration only. These are known as federal-covered securities. Exchange-listed securities and investment company issues (like mutual funds) qualify for SEC-only registration.
Although it’s called “registration by filing,” the issuer is not registering with the state. Instead, the issuer makes a notice filing, which notifies the administrator that the security will be offered or traded in that state, while regulation remains with the SEC.
Registration by coordination
This process involves registration with both the SEC and the state administrator. Registration by coordination is used for companies that sell in multiple states but don’t qualify as federally covered securities. These are often smaller or lesser-known issuers.
Registration by qualification
This form of registration is available to issuers selling securities in one state only. Securities claiming a Rule 147 federal exemption will likely register by qualification. Registration by qualification involves registration with the state administrator only and does not include SEC registration.
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