Spring 2013
Securities Regulation
Linda Boss
Module V Notes
March 14, 2013
6. EXEMPT OFFERINGS
Statutes and Regulations
 Securities Act
o Section 3(a)(11)
o Section 3(b)
o Section 4(2)
o Rule 135c
o Rule 147
o Rule 152
o Rule 155
 Regulation A
o Rules 251-263
 Regulation S
o Rules 901-905
 Regulation D
o Rules 501-508
I.
Introduction
a. Why some companies should be exempt
i. Expense
ii. Not all investors require the same level of protection
1. We’re talking about high net worth individuals with
money to invest—how much protection do they really
need?
b. Lawyers spend a lot of time trying to get their private placements to
fit within the private placement exemptions.
c. Only for ‘qualified investors’
i. have to be sophisticated plus…
ii. they have to have access to information
d. statutory language
i. 4(1)—transactions by any person other than an issuer,
underwriter, or dealer.
ii. 4(2)—transactions by an issuer not involving any public
offering
1. ‘transaction’= any type of deal. Look at it in context.
Under section 5, transactions are offers, sales,
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distributions of prospectuses, distributions of
securities,
2. what is a non-public offering?
a. Doesn’t require registration b/c we think
investors are not dumb
i. Those who can fend for themselves
II.
Section 4(2) Offerings
a. Exempts ‘transactions by an issuer not involving any public offering’
from § 5
b. Factors relevant to determining whether an offering is ‘public’
i. The number of offerees
ii. The relationship of the offerees to each other and to the issuer
iii. The number of units offered
iv. The size of the offering
v. The manner of the offering
c. SEC v. Ralston Purina Co.
i. Facts
1. Company gave certain employees company stock, about
500
ii. Issue
1. Is this a ‘public’ offering?
iii. Reasoning
1. ‘blue sky’ laws are clear that to be public, an offer need
not be open to the whole world
2. absent a showing of special circumstances, employees
are just as much members of the investing ‘public’ as
any of their neighbors in the community
3. keep in mind the broadly remedial purposes of federal
securities laws
4. the focus of the inquiry should be on the need of the
offerees for the protections afforded by registration.
5. The employees here were not shown to have access to
the kind of information which registration would
disclose
6. Qualified investors are ‘people who can fend for
themselves’
iv. CLASS NOTES
1. Supreme court’s first and only attempt defining
nonpublic offering
2. Before this case, the idea of private placement was
fewer than 35 investors, involving not a lot of securities,
not a lot of $$, all from a 1935 SEC general counsel
opinion
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3. Purina’s argument is that they’re selling only to special
employees and so it’s not a public offering since
investors are limited
4. They look at the statutory purpose and come to the
conclusion that an offering to those who are shown to
be able to fend for themselves is a transaction not
involving any public offering
5. They REJECT the idea that quantity limits based on $$,
size, # of offerings, etc. = private placement
d. Doran v. Petroleum Management Corp.
i. Facts
1. PMC offered 8 investors securities in oil drills
2. Doran accepted the offer, only one except MArty
a. Doran is certainly qualified
b. He has access to information, better than public
investors
3. Deal went sour; sued
ii. Procedure
1. PMC argued exempt because not a public offering
2. Appellate court said private
3. Reversed/remanded
iii. Reasoning
1. Consideration of the factors for public vs. private are
not exclusive
2. Looking at the following factors, ct. finds as follows
3. Number of offerees
a. # of offerees, not purchasers, is relevant number.
8 investors were offered and that’s consistent
with a finding that the offering was private
4. relationship with issuer
a. focus on relationship should be on information
available to the offerees by virtue of this
relationship
b. if plaintiffs did not possess the information
requisite for a registration statement, they could
not bring their sophisticated knowledge of
business affairs to bear in deciding whether or
not to invest
c. there must be sufficient basis of accurate
information upon which the sophisticated
investor may exercise his skills
d. the requirement that all offerees have available
the information registration would provide has
been firmly established as a necessary condition
of gaining the private offering exemption
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5. ‘availability’ of information means either disclosure of
or effective access to the relevant information
6. it might be shown the offeree had access to the files and
record of the company that contained the relevant
information
iv. CLASS NOTES
1. Can a qualified investor claim exempt just because
another investor was NOT qualified?
2. The defendant has to show that every investor was
qualified
3. Issuer also has to show that all of the offerees were
qualified
4. Qualified means
a. Sophistication
b. Knowledge and experience
c. Access to all information—any information you
would be getting in a prospectus
5. Issuer has the burden of showing that you have an
exempt transaction—even in criminal cases.
v. CLASS CHART
1. Issuer-any
2. $ limit-none
3. no offers to ‘unqualified’ investors
4. no limits on # investors
5. only qualified investors can purchase
6. ‘access’ disclosure (sliding scale)
7. resales only to ‘qualified investors’
8. no SEC filing until file registration statement.
e. Class Hypotheticals
i. Hypothetical 2
1. Madeline is going to sign a document that makes reps
and warranties that she is ‘qualified’
2. Can she sign away her rights? She’s the person we’re
trying to protect, why should issuers get around the
liability
3. § 14—any condition stipulation or provision binding
any person acquiring any security to waive compliance
with any provision of this title or of the rules and
regulations of the commission shall be void
a. her letter is VOID
ii. hypothetical 3
1. mark won state lottery of 20 million
2. PML sends mark offering circular that looks like
prospectus
3. Mark invests and wants $ back
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4. What if Mark hires Warren Buffet to be his personal
representative?
a. Warren’s not investing; mark is
b. Can you buy experience and sophistication?
c. Why not say other rules will protect him?
d. The SEC says you can buy sophistication, if you
or your investor rep has the experience and
knowledge it’s all good and you’re qualified
iii. Hypothetical 4
1. Martha manages O&G. venture capital fund.
2. She never receives drilling logs but she requested them
3. She wants out b/c no access to information
4. She’s not someone who needs protection, but she never
got access to her information
5. Is this a sliding scale where super sophistication makes
up for lack of access??
6. Maybe. Most people call this a sliding scale.
7. It was her decision to go forward and then use this as an
excuse as an ‘unsophisticated’ investor
iv. Hypothetical 5
1. O&G sells investment to mystery investor Marty
2. what if Martha sells to an unqualified investor?
3. Issuer to qualified to unqualified. What happens?
4. if qualified investor resells, it might be deemed
statutory underwriter b/c there was intent to resell and
distribute
5. If it sells to unqualified investor, at that point the issuer
has engaged in public offering. Every other investor
could not rescind b/c of that one unqualified investor.
6. Issuers are very careful to say you can’t resell.
v. Hypothetical 6
1. PM wants to sell stock to employees—ESOP
2. Any employee can invest
3. Is registration required when private company sells to
its own employees?
a. For non-public companies, rule 701 exemption
w/ SEC
b. Says if you’re selling pursuant to written plan
and purchasers are employees,
c. And you sell only up to a million, OR 15% of net
assets, or 15% of outstanding shares
d. Then you have to have a plan, some basic
financials, and how the employee
pays/withdraws
e. Becomes ‘restricted stock’
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4. What if the company goes public?
a. You have to use Form S-8
b. You have to have a written plan
c. The purchasers can only be employees
d. No limit on amounts
e. You have to have plan, and you can refer to the
SEC filings
f. You must describe any restrictions
III.
Regulation D
a. Rule 506 provides a safe harbor for the § 4(2) exemption
i. Open to all issuers
ii. Only one that is a § 4(2) exemption
b. Offerings under § 3(b) of Securities Act allows SEC to exempt from § 5
offerings up to $5 million
c. Rule 501 provides definitions
d. Rule 502 sets forth various requirements referenced by 3 types of
offerings found in 504-506
e. Rule 505
i. Excludes investment companies
ii. Disqualifies certain issuers w/ past securities law violations
f. Rule 504
i. Prohibits investment companies, blank check companies, and
Exchange Act Reporting issuers
g. Regulation D differ w/ respect to each category that is its own subject
below…
h. Aggregate Offering Price
i. Rule 504
1. Issuers can sell up to one million in securities
ii. Rule 505
1. Up to five million
iii. Rule 506
1. Unlimited amount
iv. Constraining this price limits potential scope of offering
v. Aggregation rules
1. Issuers must reduce offering price ceiling by amount of
securities sold in twelve months preceding offering
pursuant to either—
a. Offering under § 3(b); or
b. Offering made in violation of § 5
i. Purchasers
i. Regulation D limits # purchasers
ii. Rule 504
1. No limit
2. One million aggregate indirectly constrains #
purchasers
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iii. Rule 505 and Rule 506
1. 35 purchasers
2. # purchasers excludes from purchasers any ‘relative,
spouse, or relative of the spouse of a purchaser who has
the same principal residence as the purchaser’
3. excludes ‘accredited investors’ from purchaser tally
a. includes large entities and institutions, including
banks, broker-dealers, and insurance companies
b. trusts, partnerships, corporations also may apply
i. minimum 5 million total assets
c. any director, executive officer, or general partner
of issuer of securities 501(a)(4)
d. natural purpose whose individual net worth, or
joint net worth with that person’s spouse, at the
time of his purchase exceeds $1,000,000
501(a)(5)
e. natural person whose individual income
exceeded $200,000 in each of the two most
recent years or whose joint income with his/her
spouse exceeded $300,000 in each of those years
and has a reasonable expectation of reaching the
same income level in the current year 501(a)(6)
4. Rule 505 still has constrained 5 million aggregate price
iv. Rule 506
1. Must meet sophistication requirement
2. 506(b)(2)(ii)—every purchaser who is not an
accredited investor either alone or with his purchaser
representative has such knowledge and experience in
financial and business matters that he is capable of
evaluating the merits and risk of the prospective
investment, or the issuer reasonably believes
immediately prior to making any sale that such
purchaser comes within this description.
3. Factors—
a. Wealth and income
b. Experience
c. Education
d. Present investment status
e. Performance on an investment test
v. Securities Act provides for exemption from § 5 for offers and
sales to accredited investors under § 4(5) of the Act
1. Limited to $5 million established under § 3(b)
2. Issuers or reps cannot engage in ‘advertising or public
solicitation’
3. Must file notice of transaction w/ SEC under Form D
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j.
4. Rarely used by itself
vi. Issuers rely on placement agents to provide access to pools of
accredited investors
1. Rule 501(a) says issuers just has to ‘reasonably’ believe
an investor qualifies as accredited investor
vii. Regulation D resales are limited from date of investment
unless securities are registered under § 5 or selling investor
finds an exemption from § 5
viii. Regulation D has no inflation adjustment
ix. Dodd Frank
1. requires SEC to adjust 1 million net worth test for
natural person to become accredited investor to exclude
‘value of primary residence of such national person’
2. SEC must review definition of accredited investor to see
if it should be adjusted ‘for the protection of investors,
in the public interest, and in light of the economy’
3. SEC must review definition in its entirety every 4 years
x. Commonly understood definition of net worth is ‘the difference
between the value of a person’s assets and the value of the
person’s liabilities’
xi. Primary residence = home where a person lives most of the
time.
General Solicitation
i. Regulation D addresses ‘offerees’ separately from purchasers
ii. 502(c) bans general solicitations
1. applies to 505 and 506 offerings
2. 504
a. exempts issuers from 502(c) if the issuer meets
certain state law offering requirements as
outlined in Rule 504(b)(1)(i)-(iii)
b. may avoid solicitation ban if issuer sells
exclusively in a state that provides for
registration of the securities under state law
c. requires public filing and delivery to investors of
a ‘substantive disclosure document’ prior to sale
3. issue—what is a general solicitation
iii. In the Matter of Kenman Corp.
1. Facts
a. Sold limited partnership interests to 25 investors
who invested $280,000
b. No registration statement filed
c. Form D was filed
d. Securities firm mailed information concerning
the investment to unknown # of persons
i. Chosen from 6 sources
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ii. Participants in prior offerings
iii. Fortune 500 company executive officers
iv. Previous investors of $10K or more in
real estate
v. Physicians in CA
vi. Managerial engineers employed by
Hughes Aircraft co. and similar cos.
vii. Morris County, NJ Industrial Director and
selected names of presidents of certain
companies.
2. Reasoning
a. No exemption from registration was available
b. These were ‘offers’ and ‘prospectuses’
c. The exemption of 4(2) is not available to an
issuer that is engaged in general solicitation or
general advertising
d. Since this was a general advertising, the safe
harbor of Rule 506 and the 4(2) exemption were
not available.
iv. SEC No-Action Letter Mineral Lands Research & Marketing
Corporation
1. The SEC will not issue no-action letters with respect to
transactions under Regulation D
2. Proposal to offer to 600 people who are existing clients
of an officer who is an insurance broker
a. The types of relationships with the offerees that
are important in establishing no general
solicitation are those that will enable the issuer
to be aware of the financial circumstances or
sophistication of the persons with whom the
relationship exists or that otherwise are of some
substance and duration
v. Brokerage firms may actively solicit investors with a general
interest in investing in private placements
1. Solicitation cannot mention particular private
placement offering
2. Brokerage firms must have time to assess sophistication
of investors
k. Disclosure
i. Regulation D private placements don’t completely eliminate
disclosures
ii. Rule 502(b)
1. Divides Regulation D into
a. Type of investor
b. Type of offering
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2. Rule 504/non-accredited and accredited investor
a. No specific disclosure required
3. Rule 505/506/accredited investor
a. No specific disclosure required
4. Rule 505/506/non-accredited investor
a. Specific disclosure required by Rule 502(b)(2)
b. Disclosure based on type of issuer and size of
offering
i. Up to 2 million/non-exchange act
reporting company
1. Non-financial info under
502(b)(2)(i)(A)
2. Financial info under
502(b)(2)(i)(B)(1)
3. Article 8 of Regulation S-X
ii. Up to 7.5 million/non-exchange act
reporting company
1. Financial info under
502(b)(2)(i)(A)
2. Non-financial info under
502(b)(2)(i)(B)(2)
3. Financial statement info contained
S-1 for small reporting companies
iii. Over 7.5 million/non-exchange act
reporting company
1. Non-financial info under
502(b)(2)(i)(A)
2. Financial info under
501(b)(2)(i)(B)(3)
3. Financial statement info contained
in public offering registration
statement
iv. Offerings of any size/exchange act
reporting company
1. 502(b)(2)(ii)
2. either provide combo of recent
annual report, proxy statement,
and 10-K; or
3. 10-Kif contains info found in
annual report
c. must provide ‘brief description of the securities
being offered, the use of proceeds from offering,
and any material changes in the issuer’s affairs
that are not disclosed in the documents
furnished’
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d. issuer must give purchaser ‘opportunity to ask
questions and receive answers’ relating to the
offering
e. issuer must supply any additional information
necessary to verify accuracy of specific
mandatory disclosure items upon request of any
purchaser provided issuer ‘possesses or can
acquire without unreasonable effort or expense’
the information
l. Resale Restrictions
i. Generally cannot be freely resold w/ one exception
1. Rule 504 offering that complies w/ state law
registration requirement can freely resell securities
2. Small size of Rule 504 and state law restrictions limit
secondary market
ii. 505/506, 502(d) restricts resales
1. issuer must take reasonable care to discourage
investors from reselling securities
iii. restrictions on resale severely impinge the ability of investors
to realize their capital appreciation—no opportunity to
diversify portfolio
iv. private placement investors typically requires an illiquidity
discount to induce them to purchase
m. Integration
i. Integration doctrine restrains ability of issuers to
recharacterize offerings strategically
ii. Factors relevant in determining whether to integrate
transactions
1. Whether sales are part of single plan of financing
2. Whether sales involve issuance of same class of
securities
3. Whether sales have been made at or about the same
time
4. Whether the same type of consideration is received
5. Whether sales are made for the same general purpose
iii. SEC provides safe harbor under 502(a)
1. Applies six months prior to start of offering and six
months after end of offering
2. Two time periods
a. Safe harbor window
i. Beginning of pre-offering six month
period to end of post-offering six month
period
b. Six-month periods window
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i. Pre-offering and post-offering six month
periods but not time period of offering
itself
3. Sales outside safe harbor window are separate from
Regulation D offering, with one exception
a. During six month periods window, if issuer
offers or sells securities that ‘are of the same or
similar class as those offered or sold under
Regulation D’ then issuer loses safe harbor
entirely
n. Innocent and Insignificant Mistakes
i. 508
1. failure to comply w/ requirement for 504, 505, 506
offering don’t necessarily result in loss of exemptions
for an offer or sale to a particular individual or entity
ii. why allow mistakes?
1. Investors in regulation D offering are more
sophisticated compared with investors in public
offering
2. Limited in several respects
a. Does not shield issuer from SEC enforcement
actions
b. Rule 508 limits excuse to those situations where
‘failure to comply did not pertain to a term,
condition or requirement directly intended to
protect that particular individual or entity’
c. Eve if failure to comply was not related to a
requirement directly intended to protect the
particular investor suing, Rule 508 will also be
unavailable to the issuer unless the failure to
comply was ‘insignificant with respect to the
offering as a whole’
d. ‘significant’ failures are—
i. general solicitation prohibition
ii. aggregate offering price limitation
iii. limit on # purchasers
3. requires ‘good faith and reasonable attempt was made
to comply with all applicable terms, conditions, and
requirements of 504, 505, 506’
o. Disqualification
i. Rule 504
1. No disqualification provision
ii. Rule 505
1. Disqualification in certain circumstances
2. References only disqualifiers in Regulation A
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iii. Rule 506
1. Dodd-Frank requires disqualifiers ‘substantially similar’
to Regulation A
iv. Regulation A Rule 262
1. Bad acts of issuer, including predecessors or affiliated
a. Subject of SEC proceeding or examination, or
subject of stop refusal in last 5 years
b. Convicted within 5 years prior to first sale of
securities under Rule 505 of any felony or
misdemeanor w/ securities or ‘false filing’ with
SEC
c. Issuer subject to ‘order, judgment, or decree of
any court of competent jurisdiction’ in last 5
years that restrains issuer from securities
actions
2. Bad acts of key individuals and entities connected w/
issuer or offering, including director or officer of issuer,
beneficial owner of 10% more of class of its equity
securities, and any promoter of the issuer presently
connected with it in any capacity, and any person paid
for solicitation of purchasers in connection w/ Rule 505
offering, as well as partner, director, or officer of
soliciting agent
a. Conviction for felony or misdemeanor related to
purchase or sale of securities in ten years prior
b. Court order, judgment, decree in last 5 years
related to securities
3. Bad acts of soliciting agents
a. Acted as underwriter and underwrote in
securities offering under proceeding or
examination, stop order, etc.
4. Any person subject to final order from one of
following—
a. State securities commission
b. State authority that supervises banks, savings
associations, credit unions
c. State insurance commission
d. Federal banking agency
e. National credit union administration
f. Order must bar them from their activities or
violation of law or regulation of or conduct
v. Rule 507 is general disqualification, but is narrow, focusing on
issuers in past that have failed to comply w/ notice filing
requirement of 503.
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vi. SEC can waive disqualification if Commission determines, on
good cause, not necessary
p. Other Aspects of Regulation D
i. State Securities Regulation
1. ‘blue sky’ regulations
2. most states combine disclosure w/ limited merit review
3. ‘uniform’ act allows states to pick and choose among
antifraud liability, disclosure, and merit regulation
options
4. NSMIA exempts certain securities from state securities
registration requirements, those covered as exempt
offerings under Rule 506
5. Doesn’t include Rules 504 or 505 securities
6. Most states have adopted exemptions from registration
ii. Rule 504
1. Allows issuers to avoid general solicitation, disclosure,
resale restriction requirements
2. Must meet state law requirements
a. Issuer may sell securities in states that provide
for state registration of securities and ‘public
filing and delivery to investors of a substantive
disclosure document before sale’
b. Issuers may sell in states that have no state
registration requirement, so long as they comply
with registration and public filing and delivery
requirements of another state
c. Issuers may make sales ‘exclusively according to
state law exemptions from registration that
permit general solicitation and general
advertising so long as sales are made only to
‘accredited investors’ as defined in 501(a)
iii. Form D
1. 503 requires 504, 505, 506 requires Form D filing
2. has until 15th day after start of offering
3. contains basic info on issuer and offering, including
promoters of offering, 10% beneficial owners, executive
officers and directors, broker-dealers, minimum
investment required, offering price, # investors,
expenses, and use of proceeds
iv. Exchange Act Filing
1. Must file Form 8-K
2. Info in Item 701 of Regulation S-K
3. Must provide info on Form 10-K and 10-Q filings
q. The Private Placement Process
i. Hire placement agent to assist in offering
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IV.
1. Best efforts offerings
ii. Agent reviews business/finances of issuer
1. ‘due diligence’ package to give investors
iii. agent will write up private placement memorandum
1. similar info to public offering statutory prospectus
iv. agent will market offering
1. contact investors with whom agent has pre-existing
relationship
2. roadshow meetings
v. investors negotiate w/ issuer
vi. investors purchase
1. agent assists w/ subscription agreements and transfer
of money and securities
r. CLASS CHART
i. Section 4(2) Rule 506
1. Issuer—any
2. $ limit—none
3. marketing—varies
4. # investors—35 non-accredited
5. type—acredited/nonaccredited
6. disclosure—only to non-accredited
7. resales—‘restricted’
8. SEC filing—yes
9. Most people use this exemption, even those who just do
really small sales.
ii. 3(b) Rule 504 safe harbor
1. issuer-no 34 act, blank check, ‘inv cos?’
2. $ limit-1 million (12 mos.)
3. marketing—no general solicitations
4. #/type investors-no limits
5. no disclosure
6. ‘restricted’ resales
7. SEC filing-yes
iii. 3(b) Rule 505 safe harbor
1. no inv cos—no ‘bad boys’
2. $ limit- 5 million (12 mos.)
3. no general solicitations
4. # investors—35 non-accredited
5. type—accredited/non-accredited
6. disclosure only to non-accredited
7. ‘restricted’ resales
8. SEC filing-yes
Why would other exemptions be necessary?
a. Needs of small business issuers
b. Presence of alternative regulatory regime
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V.
c. Importance of national boundaries and need to respect the authority
of other countries
Regulation A
a. Provides exemption from § 5 for offerings of up to 5 million
b. Rules 251-263 of Securities Act
c. Establishes procedure for ‘mini public offering’
d. Allows certain non-exchange act reporting issuers to raise more
capital than 504 w/ fewer gun-jumping restrictions than public
offerings
e. Has disqualifying provision
f. Mandatory disclosure requirements on issuers
i. Offering statement
ii. Offering circular
iii. No need to audit financial statements
g. Immediate secondary market trading
h. Must comply w/ ‘blue-sky’ securities laws
i. CLASS CHART
i. Issuer—no ’34 act—‘bad boys’ excluded
ii. $ limit--$50 million (12 mos.)
iii. marketing—you can test the waters
iv. # investors—no limits
v. type of investor—no limit
vi. disclosure—offer circular, unaudited.
vii. Resales—none
viii. SEC filing—yes.
j. Practically, no one uses this exemption, because you still have to
register under state law. Why go through federal exemption process
when you still have to go through state exemption. If doing it in more
than one state, you also have to get reciprocity.
k. Test the Waters
i. Gun-jumping rules mirror public, focusing on 2 events
1. Filing of offering statement w/ SEC
2. Qualification of offering statement, when sales can
commence
ii. Issuers can ‘test the waters’ in pre-filing period
1. Issuers can provide writings to prospective purchasers
2. Strictly limited to pre-filing period
3. Must wait 20 days for sales after test waters
communication
iii. Can be integrated w/ later public offering, resulting in gunjumping violations
iv. Integration safe-harbor under Rule 254
1. 30 calendar days elapsed between last solicitation of
interest and filing of registration statement with SEC
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l.
VI.
Internet Offerings
i. Internet offerings through Regulation A happen, but aren’t real
popular after collapse of internet bubble.
Intrastate Offerings
a. Why exempt them?
i. Smaller in scope and are sold to investors that have a general
knowledge of the typically local companies offering the
securities, reducing the need for broad-based securities
protections of § 5
ii. Less effect on confidence of investors in national securities
marketplace
iii. State ‘blue sky’ securities regulation provides a substitute.
iv. State regulators have greater incentive and greater ability to
police the offering
v. Dormant commerce clause—if it affects intrastate commerce,
state is incapable of regulation. If it is entirely intrastate, then
the state can regulate and should regulate. Here, this is the
philosophy with intrastate offerings and Rule 147.
b. Who uses this exemption?
i. Issuers raising money only from local sources
ii. Those wanting to save money
c. National Securities Market Improvement Act of 1996 preempts state
securities registration requirement for ‘covered securities’
i. Does not include securities offered and sold under § 3(a)(11)
d. Section 3(a)(11) Offerings
i. Statute (should be read as a transaction exemption)—
1. Any security which is a part of an issue (red flag—
integration) offered and sold only to persons resident
within a single State or Territory, where the issuer of
such security is a person resident and doing business
within or, if a corporation, incorporated by and doing
business within, such State or Territory.
a. LLCs, partnerships, etc. are ‘persons’ doing
business
2. SEC construes this narrowly.
ii. This exemption should be plan B—you shouldn’t rely on it. It
should be relied on if you screw up and another exemption
didn’t work out for you. Always use another exemption first.
This one is too risky.
iii. Securities Act Release No. 4434
1. ‘issue’ concept
a. an offer to a on-resident not allowed
b. may likely be considered an integrated part of an
offering previously made or proposed to be
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made, so if those include non-residents, be
careful.
c. Even secondary market can only be residents
i. Obtain assurances
2. Doing business within the state
a. Must have substantial business operational
activities in the state of incorporation
b. If proceeds are used to conduct business outside
of state, no exemption
c. Don’t create a new entity—it will be considered
one.
3. Residence within the state
a. Presence in the state isn’t enough to be a
resident
i. Includes military
b. Formal reps of residency isn’t enough—you
should rely on more
c. If the offering is too large—we’ll presume it’s
doubtful intrastate
4. Resales
a. Sale to one non-resident destroys exemption for
all residents
b. If they come to rest, and then are re-sold, might
not defeat exemption
c. The non-residence of an underwriter or dealer
isn’t pertinent as long as ultimate distribution is
solely to residents of that state
iv. Busch v. Carpenter
1. Facts
a. Sonic was UT corporation, sold securities to UT
residents, then was contacted about a merger w/
a company in IL
b. Money from securities sale was never used in UT
c. Plaintiffs are CA residents and bought stock
through brokerage account in UT
2. Procedure
a. DC said resale of stock to nonresidents occurred
after securities came to rest in UT
3. Reasoning
a. ‘coming to rest’
i. SEC says b/c defendants have burden to
show right to exemption, they have
burden of showing original buyers bought
w/ investment intent
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ii. Rejects SEC. a seller seeking SJ makes
prima facie showing that offering was
consummated within state by showing
stock was sold only to residents of that
state. Issuer not required to disprove all
possible circumstances that might
establish the stock hasn’t come to rest.
iii. Purchaser has burden of producing
contrary evidence on this issue when
seller has satisfied facial requirement of
statute
4. ‘doing business’
a. doing business refers to activity that actually
generates revenue within an issuer’s home state
b. more substantial activity than that which would
exercise personal jurisdiction
c. fact issue still exists regarding Sonic’s use of the
proceeds, since corporation never did more than
maintain an office in UT
v. when are sales to investors outside the states integrated?
1. Same general purpose
2. Same plan of financing
3. Same consideration
4. Close in time to one another
5. No view on how to balance these factors if they go
different ways
vi. When do sales to investors within the state ‘come to rest’
1. Depends on ‘investment intent’
2. Shouldn’t rely upon passage of time
vii. CLASS CHART
1. Issuer—resident/incorporated ‘within’ state
2. $ limits-none
3. marketing—only offer to ‘in state residents’
4. # investors no limits
5. only sell to ‘in state residents’
6. no disclosure requirement, subject to state bleu sky
laws
7. only ‘in state’ resales until the securities come to rest
8. no SEC filing, until the registration statement.
a. Part II of the registration statement requires you
to come clean and expose all past relationships,
describing them in detail.
e. Rule 147
i. Safe harbor statute
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1. Those who fail to meet these requirements may still be
exempted
ii. CLASS CHART
1. Issuer—organization or principal office, using the 80%
test
2. $ limits—none
3. marketing—‘principal office/residence’
4. # investors—none
5. type of investors—‘principal office/residence’
6. no disclosure, subject to state blue sky laws
7. resales—9 month safe harbor restriction
8. no SEC filing until you file the registration statement.
iii. How is Rule 147 different from 3(a)(11)?
1. It gives you some definitions and objective standards
for issuer, marketing, and type of investor.
2. Gives you an objective standard for when securities
‘come to rest’
3. Bright-line test
iv. Exchange Act Release No. 5450
1. Transaction concept
a. Exemption covers only specific transactions and
not securities themselves
2. ‘part of an issue’
a. certain offers and sales of securities will be
deemed not to be part of an issue and therefore
not be integrated
b. no definition of ‘part of an issue’
i. apply five factor integration test
3. ‘person resident within’
a. interpreted narrowly
b. provides objective standards for when a person
is considered a resident within a state for
purposes of the rule and when securities have
come to rest within a state
4. ‘doing business within’
a. strict compliance
b. business should be located within the state, and
principal or predominant business must be
carried on there
c. substantially all of the proceeds of the offering
must be put to use within the local area
d. provides specific % amounts of business that
must be conducted withint eh state, and of
proceeds from the offering that must be spent in
connection with such business
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5. Synopsis of Rule 147
a. Preliminary notes
i. Safe harbor
ii. Only for issuer—not secondary market
b. Transactions covered 147(a)
i. Issuer must be resident and doing
business w/in state or territory
ii. Offerees and purchasers must be resident
iii. Resales for period of 9 months after the
last sale which is part of an issue must be
limited as provided—this gets rid of the
prohibition on selling to out of state
investors.
iv. Certain offers and sales of securities by or
for the issuers will be deemed not ‘part of
an issue’ for purpose of this rule only.
c. ‘part of an issue’ 147(b)
i. all securities sold prior to 6 months
before or after the sale are deemed not
part of an issue—this gets rid of the issue
of integration.
d. ‘nature of the issuer’ 147(c)—‘person resident
within’ 147(c)(1)
i. corporation, limited partnership or
business must be incorporated or
organized pursuant to the laws of such
state or territory
e. ‘nature of the issuer’ 147(c)—‘doing business
within’ 147(c)(2)
i. 80% of gross revenues and subsidiaries
on consolidated basis for--most recent
fiscal year; or 6 month period after, or 12
months before that period, were derived
from operation of a business or property
located in or rendering of services within
the state
ii. 80% of issuer’s assets and subsidiaries at
end of most recent fiscal semi-annual
period prior to the first offer of any part
of the issue are located within such state
iii. at least 80% of net proceeds to issuer
from sales made pursuant to the rules are
intended to be and are used in connection
with the operation of a business or
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property or the rendering of services
within such state or territory; and
iv. issuer’s principal office is located in the
state
f. offerees and purchasers—‘persons resident’
147(d)
i. principal residence in state
ii. if purchasing on behalf, that person must
be resident
g. limitations on resales 147(e)
i. during period securities are offered/sold,
and 9 months after last sale, resales can
only be made to residents
h. precautions against interstate offers and sales
147(f)
i. requires issuers to take steps to preserve
the exemption provided by the rule
ii. if issuer-1. place a legend on certificate stating
securities aren’t registered under
act and set forth limitations on
resale
2. issue stop transfer instructions to
issuer’s transfer agent
3. obtain written representation
from each purchaser as to his
residence
iii. if issuer selling to non-issuer to resale
within 9 months
1. do steps 1 and 2 above
2. issuer must disclose in writing the
limitations on resale
i. operation of rule 147
i. not an exemption from civil liability
provisions of 12(a)(2) or anti-fraud
provisions of Section 17 of the Act or 12b5 of Securities Exchange Act
ii. available only for transactions by issuers,
not secondary offerings.
f. CLASS HYPOTHETICALS
i. Hypo #1
1. Does the 40% out of state customers/supplies affect the
exemption? Are they doing business within the state?
Are you within the Rule 147 safe harbor?
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a. Does this satisfy 80% test? An order is a really
valuable asset, and that came from out of state.
But the operations are all located in-state, that’s
where the order could originate. The ‘order’ is
what makes this operation work—that’s the
origination of the assets of the corporation. And
they’re all out of state.
b. Are these orders subject to state regulation? The
activities that produce the orders are subject to
those state regulations. That’s why we’re okay
with this amount of business being ‘within the
state’
c. The notion is that it’s ‘in state’ if the state
regulator could regulate fully the business and
its operations and anything related to this
offering, so that there’s no reason to even have
additional federal regulation or enforcement,
because the in state regulator could do a
complete job.
d. That chosen action, that order, asset, ability to
sue a customer and say you have to pay, is
something that could be managed in-state. Do
things change if this company were buying land
in other states?
i. Pennoyer says when it’s land, a state has
complete jurisdiction over land. If this
involved land, your exemption is probably
gone. NC securities commission can’t
regulate that land in that other state.
e. The argument is that the 60/40 ratio shouldn’t
even matter, because all of the orders are
originating and coming from inside NC.
2. What about proceeds being used to buy new warehouse
in SC and order center in High Point?
a. By building a new warehouse in SC with the
proceeds, you should be concerned.
b. For exemption, use of proceeds must meet the
80% test and use of proceeds is part of the word
‘within’
c. If 85% go to the call center, and 15% go to the
warehouse, you’re probably good. If the real
estate outside the state is a de minimis problem,
they’re not going to deny you the exemption.
ii. Hypo #2
1. First issue bullet
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Securities Regulation
a. This is an outside investor—not within
intrastate offering exemption
b. It’s a VC firm, though—so I’m sure Reg. D or 4(2)
would work. Why wouldn’t they?
c. Is this private placement? Is that private
placement part of this intrastate offering? This is
an integration issue.
d. You should use the 9 month safe harbor.
2. Second issue bullet
a. Can insiders use the intrastate offering
exemption?
b. The SEC has said that you can’t use the safe
harbor if you’re an insider, but the courts and
SEC have accepted that you can use it as an
insider, you’re going to be treated as an
intrastate issuer. No safe harbor assurances, but
it’s still a possibility.
c. Is edgar a ‘control person’? yes. He’s the CEO.
iii. Hypo #3
1. First bullet issue
a. Can it use intrastate if incorporated in Delaware
w/ headquarters in Atlanta?
b. We might need more facts. What if they had a NC
office and only registered reps from NC are
working on this deal, and all records of this deal
are maintained in NC, and only sold to NC
residents, and NC securities commission can
regulate this fully. In those circumstances, it
might be okay.
c. If it’s a corporation, it does have to be
incorporated in the state—that’s for the issuer,
not the underwriter as in this case.
d. The underwriter is an ‘investor’ in this case;
that’s why this applies.
2. Second bullet issue
a. If they do all follow up phone calls in NC, as long
as securities go to NC residents, we’re good.
iv. Hypo #4
1. Offering circular to various investors. Any issues?
2. Resident in SC—lost exemption. She’s not a NC resident.
a. SEC says address & driver’s license is enough for
residency—safe harbor
3. Notarized promise—not enough. She still resides in VA.
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Securities Regulation
a. If you could get out of state investors this way,
this would be a waiver of the provisions of the
Act and void under the statute.
4. 6 months vacation home in SC—mailing address in
NC—
a. his intent is to stay in NC—hilton head is just a
vacation place, not a primary residence.
5. Customers fill out form stating NC residences and attach
photocopy of NC driver’s license
a. The statute is a strict rule, but the safe harbor in
effect allows that if the person is a resident, it’s
good but there’s no reasonable belief provision.
So you might want to check up.
v. Hypo #5
1. In oct. carl buys shares, in april his daughter gets into
private law school and he has to sell his shares
a. There are no resales allowed generally
b. You can resale if the securities have come to rest
in-state—after that you’re not part of the issue.
You’re trading on a secondary market. How long
do you have wait?
i. We don’t know according to the statute
ii. But the Rule 147 says 9 months.
iii. Before selling to the in-state resident,
make it clear there is no resale.