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Securities Exemptions 2017-10-02T21:08:53+00:00

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Federal and California Securities Exemptions

Federal and California Securities Exemptions Summary

Federal and California securities exemptions allow for the offer and sale of securities without federal registration with the Securities and Exchange Commission or qualification with the California Department of Business Oversight. Every offer or sale of an equity instrument, such as a share of stock in a corporation or s-corporation, LLC membership interest, or partnership interest should be carefully reviewed by an attorney to ascertain whether or not a security is present in the transaction and if this securities exemption will be required to avoid registration or qualification. Just as equity interests need to be examined to determine if a security is present, so do debt instruments such as bonds, debentures, convertible notes, and even promissory notes. These debt instruments are capable of being securities and thus securities exemptions will be required to avoid registration or qualification. The proper use of securities exemptions are important to:

• Legally raise capital from investors;

• Avoid criminal or civil liability for securities fraud; and

• Attract investors by providing all legally required documentation.

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Federal and California Securities Exemptions Details

Federal Registration of Securities

Unless securities exemptions are available, all offers or sales of securities are required to be registered under the Federal Securities Act of 1933.

Federal Securities Exemptions

The following is not an exhaustive list of federal securities exemptions from under the Federal Securities Act of 1933, but includes the most commonly used federal securities exemptions.

Nonpublic Offering Securities Exemptions

Under § 4(2) of the Securities Act of 1933, as amended August 20, 1964, transactions by an issuer not involving any public offering are exempt from registration under the Securities Act of 1933. In order to qualify under § 4(2) of the Securities Act of 1933, the investors must:

  • Be a “sophisticated” investor or be able to bear the investment’s economic risk;
  • Have access to the type of information normally provided in a prospectus; and
  • Agree not to resell or distribute the securities to the public.

A sophisticated investor is one having the knowledge and experience necessary to evaluate the merits and risks of an investment.

Whether a transaction involves a public offering is a question of fact and necessitates consideration of all circumstances, including the relationship between the issuer and investors and the nature, scope, size, type, and manner of the offering.

The nonpublic offering exemption must be interpreted in the light of the statutory purpose of the Securities Act of 1933, which is to protect investors by promoting full disclosure of information thought necessary to informed investment decisions. S.E.C. v. Ralston Purina Co., 346 U.S. 119, 124, 125 (1953). The sale of securities to promoters who take the initiative in founding or organizing the business would come within the exemption. U.S. Securities and Exchange Commission Release No. 33-4552. The transaction tends to become public when the promoters begin to bring in a diverse group of uninformed friends, neighbors, and associates. Id. Public advertising is incompatible with a private offering, as are the use of a securities exchange for placement, sales to underwriters, and other circumstances.

Civil liability and criminal sanctions for fraud arising from the Securities Act of 1933 are applicable despite the availability of an exemption from registration.

Regulation D Securities Exemptions

Regulation D was enacted to provide a relatively uniform set of federal securities exemptions for coordination with Blue Sky laws. The limited offering exemption adopted by California is, in many ways, compatible with Regulation D.

Under Regulation D, a security is exempt from registration for limited, private offerings of securities when:

  • The offers and sales do not exceed $1,000,000.00 regardless of the number of investors;
  • The offers and sales do not exceed $5,000,000.00 and there are no more than 35 unaccredited investors; or
  • The offers and sales to no more than 35 “sophisticated” investors other than accredited investors.

For purposes of Regulation D, an accredited investor is a person who, at the time securities are sold to that investor, is:

  • A bank under § 3(a)(2) of the Securities Act of 1933;
  • An insurance company under § 2(13) of the Securities Act of 1933;
  • An investment company registered under the Investment Company Act of 1940;
  • A business development company under § 2(a)(48) Investment Company Act of 1940;
  • A small business development company under § 301 of the Small Business Investment Act of 1958;
  • An government employee benefit fund with assets over $5,000,000.00;
  • An employee benefit plan under the Employee Retirement Income Security Act of 1974;
  • A private business development company under § 202(a)(22) of the Investment Company Act of 1940;
  • A savings & loan or other institution under § 3(a)(5)(A) of the Securities Act of 1933;
  • A broker or dealer registered under § 15 of the Securities Exchange Act of 1934;
  • An exempt organization under § 501(c)(3) of the Internal Revenue Code with assets over $5,000,000.00;
  • A director, executive officer, general partner of an issuer or the issuer of securities;
  • An individual whose net worth exceeds $1,000,000.00;
  • An individual whose income exceeded $200,000.00 per year ($300,000.00 with spouse) in the last two years;
  • A trust with assets over $5,000,000.00 directed by a sophisticated person not formed for the purpose;
  • An entity owned by only accredited investors.

Under Regulation D, the issuer must disclose specified information, including financial information. 17 Code of Federal Regulations § 230.502(b). This disclosure requirement does not apply if the issue is less than $1,000,000.00 or if the offer and sale is made solely to accredited investors. 17 Code of Federal Regulations § 230.504; 17 Code of Federal Regulations § 502(b)(1). Disclosure information, when required, must be given to unaccredited investors a reasonable time before the sale. 17 Code of Federal Regulations § 230.505; 17 Code of Federal Regulations § 230.506. The information given to unaccredited investors must include any information given to accredited investors. 17 Code of Federal Regulations § 230.502(b)(2)(iv). The issuer must also provide each investor the opportunity to ask questions and receive answers about the offering and give investors time to verify the information given by the issuer. 17 Code of Federal Regulations § 230.502(b)(2)(v). Unless under Rule 504, no general solicitation or advertising may be used in the offer and sale under Regulation D. 17 Code of Federal Regulations § 230.504(b)(1). Securities issued under Rule 505 and/or 506 may not be resold without registration. However, under certain circumstances, issuances in accordance with Rule 504 need not be registered before they are resold. 17 Code of Federal Regulations § 230.502(d); 17 Code of Federal Regulations §230.504(b)(1). Issuers offering or selling under the exemptions available under Regulation D must file a notice with the Securities and Exchange Commission. 17 Code of Federal Regulations § 230.503.

Regulation A Securities Exemptions

Regulation A allows for exemption from registration of the Securities Act of 1933 if the issuer is not subject to §§ 13 or 15(d) of the Securities Exchange Act of 1934 if the total issuance will not exceed $5,000,000.00, including $1,500,000.00 in secondary sales less the offering price of all sales made within the last 12 months under Regulation A. 15 United States Code §§ 77a – 77aa; 17 Code of Federal Regulations § 251(b). An issuer may deliver disclosure documents or scripted broadcast advertisements to determine interest in securities, but may not make oral offers until Form 1-A has been filed with the Securities and Exchange Commission. 17 Code of Federal Regulations § 230.254(a); 17 Code of Federal Regulations § 230.251(d)(1)(i). A form 2-A must be filed with the Securities and Exchange Commission every six months to report sales and uses of sale proceeds. 17 Code of Federal Regulations § 230.257.

Intrastate Securities Exemptions

Under SEC Rule 147, offers and sales made by an issuer doing business in a particular state to investors in that same state are exempt from the registration requirements of the Securities Act of 1933. 17 Code of Federal Regulations § 147; 17 Code of Federal Regulations § 147(c)(1); 17 Code of Federal Regulations § 147(c)(2); 17 Code of Federal Regulations § 117(d). Shares issued in reliance upon SEC Rule 147 may only be resold to persons residing in the same state until nine months after the last date the securities were issued. 17 Code of Federal Regulations § 230.147(e). Issuers must take precautions to ensure interstate sales do not occur until at least nine months after the last date the securities were issued. 17 Code of Federal Regulations § 147(f).

California Qualification of Securities

The California Corporate Securities Law of 1968 requires that all offers and sales of securities in California be qualified unless expressly exempt or not subject to qualification in both issuer and non-issuer transactions as well as reorganization. California Corporations Code §§ 25110, 25120, 25130.

California Securities Exemptions

The following is not an exhaustive list of California securities exemptions from qualification under the California Corporate Securities Law of 1968, but includes the most commonly used securities exemptions.

The Limited Offering Exemption

The main purpose of the limited offering exemption is to provide the promoters of small businesses with the ability to sell securities to family members, friends, business associates, and sophisticated investors with whom the issuer does not have a preexisting relationship, but the exemption is available to other situations as well. The number of investors to whom offers can be made is not limited, but the actual number of purchasers is limited to 35. California Corporations Code § 25102(f)(1). There are no disclosure requirements under the limited offering exemption, but untrue statements or omissions of material facts are prohibited. 10 California Reg. Code § 260.102.14; California Corporations Code § 25401.

The limited offering exemption does not limit the value of securities that may be offered or sold but otherwise are similar to the provisions of Regulation D. California Corporations Code § 25102(f); 17 Code of Federal Regulations §§ 230.501 – 230.506.

If the issuance of securities relies upon the limited offering exemption but fails to meet the requirements of the limited offering exemption and the securities are not qualified, investors may rescind their purchase of the securities or seek damages from the issuer. Criminal sanctions may also be imposed.

The Small Offering Exemption

The small offering is useful in some instances where the limited offering exemption cannot be satisfied but is generally only used in such cases.

Under the small offering exemption, the offer and sale of securities is exempt from qualification where there are less than thirty-five beneficial owners of the securities, and the securities are issued in only one class of ownership. California Corporations Code § 25102(h). The small offering exemption does not allow any offer or sale to be advertised and does not permit the payment of selling expenses in connection with the offer and sale. California Corporations Code §§ 25102(h)(1), 25014; 10 California Code of Regulations § 260.102.7. Likewise, promotional consideration may not be paid in connection with an issuance under the small offering exemption. California Corporations Code § 25102(h)(3).

The consideration paid by an investor to the issuer for the securities under the small offering exemption may only be:

  • The assets of a going concern;
  • Cash or Cancellation of Indebtedness; or
  • Cash Only.

Unless there is only one investor, any mixing of consideration types is not permitted. California Corporations Code § 25113.

Within ten days of receiving consideration for the sale of securities under the small offering exemption, the issuer must send a notice, signed by a member of the State Bar of California, to the Commissioner of Corporations containing the attorney’s opinion that the exemption is available. California Corporations Code § 25102(h)(4). A fee for filing the notice with the Commissioner of Corporations must be included, and it is scaled depending upon the value of securities sold. Failure to provide notice as required does not destroy the exemption, but the fine for non-compliance is equal to the fee required for qualification of the securities. Id.

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