An exempt transaction is a type of securities transaction where a business does not need to file registrations with any regulatory bodies, provided the number of securities involved is relatively minor compared to the scope of the issuer’s operations and that no new securities are being issued. Exempt securities are the instruments used that the government backs, which have tax-exempt status. An exempt transaction is a securities exchange that would otherwise have to register with the Securities and Exchange Commission (SEC) but does not because of the nature of the transaction in question.
How an Exempt Transaction Works?
Exempt transactions cut down the amount of paperwork needed for relatively minor transactions. For example, it would be a big hassle to perform a filing with the SEC every time a non-executive employee wanted to sell back some of the company’s common shares he or she purchased as part of an employee stock purchase plan.
Types of Exempt Transactions
A private placement or Reg D offering is a type of exempt transaction in which the securities are not offered to the public, but are instead sold privately to an accredited investor. According to the SEC, an accredited investor can be:
• An insurance company, bank, business development company, small business investment company, or registered investment company
• An employee benefit plan administered by a bank registered investment company, or insurance company
• A tax-exempt charitable organization
• Someone with at least $1 million in net worth, excluding his or her primary residence
• A person with more than $200,000 in income, or joint income of more than $300,000 with a spouse in both of the previous two years
• An enterprise owned by accredited investors
• A general partner, executive officer, or director of the company selling the securities
• A trust with assets of at least $5 million, as long as it has not been formed just to buy the securities in question
Other types of exempt transactions include Reg A offerings, also known as small business company offerings, which permit the issuing company to raise no more than $5 million in 12 months. This allows smaller companies to access securities markets to raise capital. Rule 147 offerings, or intrastate offerings, are also exempt. Transactions with financial institutions, fiduciaries, and insurance underwriters may be considered exempt. Unsolicited orders, which are those executed through a broker at the request of his or her client, are also considered exempt. Even with exempt transactions, investors and companies are responsible for any misleading or false statements. Usually, an exempt transaction involves a small amount of money or an accredited or sophisticated investor, or does not, for some other reason, warrant a full registration. However, even exempt transactions are subject to some regulations, such as anti-fraud provisions. Investors and companies can still be held liable to misleading or false statements made on behalf of the company, the offering, or the securities, even if the transaction is exempt. And while exempt transactions may not need to be registered with state securities regulators, those state authorities retain the authority to investigate fraud, collect associated state fees, and enforce state filing requirements. Therefore, companies should take care to remain in compliance with state securities regulations, even if their offerings and transactions are exempt under federal filing regulations.
What is a private placement?
A securities offering exempt from registration with the SEC is sometimes referred to as a private placement or an unregistered offering. Under the federal securities laws, a company may not offer or sell securities unless the offering has been registered with the SEC or an exemption from registration is available. Generally speaking, private placements are not subject to some of the laws and regulations that are designed to protect investors, such as the comprehensive disclosure requirements that apply to registered offerings. Private and public companies engage in private placements to raise funds from investors. Hedge funds and other private funds also engage in private placements. As an individual investor, you may be offered an opportunity to invest in an unregistered offering. You may be told that you are being given an exclusive opportunity. The opportunity may come from a broker, acquaintance, friend or relative. You may have seen an advertisement regarding the opportunity. The securities involved may be, among other things, common or preferred stock, limited partnerships interests, a membership interest in a limited liability company, or an investment product such as a note or bond. Keep in mind that private placements can be very risky and any investment may be difficult, if not virtually impossible to sell. Unregistered offerings often can be identified by capitalized legends placed on the offering documents and on the certificates or other instruments that represent the securities. The legends will state that the offering has not been registered with the SEC and the securities have restrictions on their transfer. You should read the offering documents carefully to understand the risks involved.
What is Regulation D?
When reviewing private placement documents, you may see a reference to Regulation D. Regulation D includes three SEC rules—Rules 504, 505 and 506—that issuers often rely on to sell securities in unregistered offerings. The entity selling the securities is commonly referred to as the issuer. Each rule has specific requirements that the issuer must meet. If you have reason to believe that an unregistered offering claiming to rely on one of these rules does not satisfy the applicable requirements, consider this a red flag about the investment.
Rule 504
Rule 504 permits certain issuers to offer and sell up to $1 million of securities in any 12-month period. These securities may be sold to any number and type of investor, and the issuer is not subject to specific disclosure requirements. Generally, securities issued under Rule 504 will be restricted securities (as further explained below), unless the offering meets certain additional requirements. As a prospective investor, you should confirm with the issuer whether the securities being offered under this rule will be restricted.
Rule 505
Under Rule 505, issuers may offer and sell up to $5 million of their securities in any 12-month period. There are limits on the types of investors who may purchase the securities. The issuer may sell to an unlimited number of accredited investors, but to no more than 35 non-accredited investors. If the issuer sells its securities to non-accredited investors, the issuer must disclose certain information about itself, including its financial statements. If sales are made only to accredited investors, the issuer has discretion as to what to disclose to investors. Any information provided to accredited investors must be provided to non-accredited investors.
Rule 506
An unlimited amount of money may be raised in offerings relying on one of two possible Rule 506 exemptions. Similar to Rule 505, an issuer relying on Rule 506(b) may sell to an unlimited number of accredited investors, but to no more than 35 non-accredited investors. However, unlike Rule 505, the non-accredited investors in the offering must be financially sophisticated or, in other words, have sufficient knowledge and experience in financial and business matters to evaluate the investment. This sophistication requirement may be satisfied by having a purchaser representative for the investor who satisfies the criteria. An investor engaging a purchaser representative should pay particular attention to any conflicts of interest the representative may have. As with a Rule 505 offering, if non-accredited investors are involved, the issuer must disclose certain information about itself, including its financial statements. If selling only to accredited investors, the issuer has discretion as to what to disclose to investors. Any information provided to accredited investors must be provided to non-accredited investors.
What should you do before investing?
Private placements may be pitched as a unique opportunity being offered to only a handful of investors, including you. Be careful. Don’t be fooled by this high-pressure sales tactic. Even if the deal is “unique,” it may not be a good investment. It is important for you to obtain all the information that you need to make an informed investment decision. In fact, issuers relying on the Rule 505 and 506(b) exemptions from registration must provide non-accredited investors an opportunity to ask questions and receive answers regarding the investment. If an issuer fails to adequately answer your questions, consider this a warning against making the investment. Unlike registered offerings in which certain information is required to be disclosed, investors in private placements are generally on their own in obtaining the information they need to make an informed investment decision. Investors need to fully understand what they are investing in and fully appreciate what risks are involved. In practice, issuers often provide a document called a private placement memorandum or offering memorandum that introduces the investment and discloses information about the securities offering and the issuer. However, this document is not required and the absence of this document or similar disclosure may be a red flag to consider before investing. Moreover, private placement memoranda typically are not reviewed by any regulator and may not present the investment and related risks in a balanced light.
All issuers relying on a Regulation D exemption are required to file a document called a Form D no later than 15 days after they first sell the securities in the offering. The Form D will include brief information about the issuer, its management and promoters, and the offering itself.
What if my broker recommends the investment?
If your broker recommends the investment, you should know that your broker, along with his or her firm, has a duty to conduct a reasonable investigation of the investment and the issuer’s representations about it. The scope of the investigation depends on the circumstances of the investment, including its complexity and the risks involved. For example, the private placement of shares by a large public company may warrant less investigation than a start-up with little or no track record. Generally, a broker should not just rely blindly on the issuer for information but should separately investigate and verify an issuer’s statements and claims. If your broker is recommending the investment and fails to satisfy its duties to investigate the issuer and the offering, this failure could constitute a violation of the antifraud provisions as well as other federal securities laws. In addition, your broker must determine whether an investment in the private placement is suitable for you. This means your broker will have to consider factors such as your age, financial situation, current and future needs, investment objectives and tax status. Your broker’s duties, however, should not substitute for your own judgment in making the investment. Your broker can assist and enable you to better understand the opportunity and risks, as well as investigate and gather additional information, but it is your money, your risk and your decision whether to invest. You should also ask about the compensation your broker is receiving for the transaction and any relationships, business ties or other conflicts of interest that may exist between your broker and the issuer.
What should I know about restricted securities?
Generally, most securities that you acquire in a private placement will be restricted securities. You should not expect to be able to easily and quickly resell your restricted securities. In fact, you should expect to hold the securities indefinitely. There are two principal things to think about before buying restricted securities. The first is that unless you have made arrangements with the issuer to resell your restricted securities as part of a registered offering, you will need to comply with an exemption from registration to resell. One rule commonly relied upon to resell requires you to hold the restricted securities for at least a year if the company does not file periodic reports (such as annual and quarterly reports) with the SEC. You may wish to hire an attorney to help you comply with the legal requirements to resell restricted securities. Issuers may require a legal opinion that you satisfy an exemption to resell your restricted securities. The second thing to think about is whether they are easy to sell. This issue primarily affects the sale of restricted securities in private companies. Information about a private company is not typically available to the public, and a private company may not provide information to you or your buyer. The restricted status of your securities may also transfer to your buyer. For these reasons, it may be difficult to attract buyers. In addition to these considerations, specific contractual restrictions that you may enter into when investing may prevent you from freely transferring the securities.
What else should I know?
Despite not being subject to the same disclosure obligations as registered offerings, private placements are subject to the antifraud provisions of the federal securities laws. Any information provided must be true and may not omit any material facts necessary to prevent the statements made from being misleading. You should be aware that it may be difficult or impossible to recover the money you invest in an offering that turns out to be fraudulent. In addition, even though the offering may be exempt from SEC registration, the offering may have to separately comply with state securities laws, including state registration requirements or a state exemption from registration. Private placements may offer great opportunity. However, the attractive potential rewards often come with high risks of loss.
Private Placement Lawyer
When you need a private placement lawyer in Utah, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506
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