Exemptions from Registration - Series 66

Exempt Securities

Not all securities need to be registered with the state Administrator before they can be offered or sold. The Uniform Securities Act identifies certain categories of securities that are exempt from the registration requirement. These exempt securities are excluded because they are either issued by entities that are already subject to extensive regulation, or because the nature of the security makes registration unnecessary for investor protection.

It is critically important to understand that an exemption from registration does not provide an exemption from the anti-fraud provisions of the USA. Even if a security is exempt from registration, any person involved in selling it is still subject to the fraud, manipulation, and deceptive practice prohibitions. The anti-fraud provisions of the USA apply to all securities and all transactions, regardless of exemptions.

The following categories of securities are exempt from state registration under the USA:

U.S. government securities: Securities issued, insured, or guaranteed by the United States government or any agency or instrumentality of the United States, including Treasury bills, notes, bonds, and agency securities (Ginnie Mae, Fannie Mae, Freddie Mac)
Canadian government securities: Securities issued by the government of Canada, its provinces, or political subdivisions (when offered or sold in compliance with the USA)
State and municipal securities: Securities issued, insured, or guaranteed by any state, municipality, or political subdivision of a state, including municipal bonds and revenue bonds
Foreign government securities: Securities issued by a foreign government with which the United States maintains diplomatic relations (designated by specific treaty or executive recognition)
Bank and financial institution securities: Securities issued by banks, savings institutions, or trust companies organized under the laws of the United States or any state, provided they are supervised and examined by a state or federal authority
Public utility and railroad securities: Securities issued by companies regulated by a public utility commission, the Interstate Commerce Commission, or similar regulatory body
Federal covered securities: As discussed in Chapter 2, securities covered under NSMIA (listed securities, investment company securities, Reg D Rule 506 offerings)
Nonprofit organization securities: Securities issued by organizations operated exclusively for religious, educational, benevolent, fraternal, charitable, or reformatory purposes, provided no part of the net earnings benefits any private person
Insurance company securities: Securities (stocks) issued by insurance companies authorized to do business in the state, provided the company is subject to supervision by the state insurance commissioner
Promissory notes and commercial paper: Notes, drafts, or bills of exchange that mature within nine months (270 days), have a minimum denomination of $50,000, are rated in the top three categories by a nationally recognized rating agency, and are not offered to the general public

Exempt Security: A security that is permanently exempt from the state registration requirement due to the nature of the issuer or the security itself. The exemption applies to the security regardless of how or to whom it is sold. However, anti-fraud provisions still apply to all exempt securities.

Exempt Transaction: A specific type of transaction that is exempt from the registration requirement. The exemption applies to the manner of the sale, not the security itself. The same security might be exempt in one type of transaction but require registration in another.

The distinction between exempt securities and exempt transactions is critical. An exempt security is always exempt regardless of the transaction. An exempt transaction exempts only that particular transaction, not the security itself. For example, a stock sold in a private placement (exempt transaction) would still need to be registered if later sold in a public offering. Also remember: anti-fraud rules always apply to both.

Exempt Transactions

In addition to exempt securities, the USA provides exemptions for certain types of transactions. An exempt transaction means that the security does not need to be registered for that particular sale, even if the security itself is not exempt. Exempt transactions under the USA include the following:

Isolated Non-Issuer Transactions

An isolated non-issuer transaction is a sale that does not involve the issuer, an underwriter, or a regular pattern of trading. This exemption covers occasional, infrequent sales by ordinary investors who are not in the business of selling securities. For example, when an individual shareholder sells stock to a neighbor in a one-time, private transaction, this would be an isolated non-issuer transaction and would not require registration of the security.

The key elements are: (1) the transaction is isolated (not part of repeated or successive transactions), (2) the seller is not the issuer (it is a secondary market transaction), and (3) there is no general solicitation or advertising. This exemption is not available for ongoing trading activity or for issuers selling their own securities.

Transactions with Institutional Investors

Transactions between the issuer (or any other person) and institutional investors are exempt from registration. Institutional investors include banks, savings institutions, trust companies, insurance companies, investment companies, pension and profit-sharing trusts, broker-dealers, and other persons designated by rule of the Administrator. The rationale is that institutional investors are sophisticated enough to evaluate investment risks without the protections of the registration process.

Unsolicited Brokerage Transactions

An unsolicited brokerage transaction occurs when a customer initiates a purchase or sale of a security without any recommendation or solicitation from the broker-dealer or agent. Because the transaction is customer-initiated, the registration process is not needed to protect the customer. The broker-dealer simply executes the order as directed by the customer. The broker-dealer must be able to demonstrate that the order was truly unsolicited, which is typically done through order ticket markings indicating the trade was unsolicited.

Transactions with Existing Security Holders (Preemptive Rights)

Preemptive rights offerings are exempt transactions under the USA. When a corporation offers additional shares to its existing shareholders on a pro rata basis, allowing them to maintain their proportional ownership, the transaction is exempt from registration requirements. This exemption recognizes that existing shareholders already have a relationship with the issuer and access to information about the company.

The exemption also applies to stock dividends, stock splits, and other distributions to existing shareholders where no additional consideration is paid. The rationale is that these transactions do not involve selling securities to new investors who might need the protection of the registration process.

MegaCorp Inc. announces a rights offering to its existing shareholders. Each shareholder receives one right for each share held. Ten rights plus $25 allows the shareholder to purchase one additional share. This transaction is exempt from registration because it is an offering to existing security holders. However, if a shareholder sells the rights themselves on the open market to a third party, that secondary market transaction is also exempt as an isolated non-issuer transaction (assuming it is not a regular pattern of sales).

Fiduciary Transactions

Transactions executed by a fiduciary (such as an executor, administrator, sheriff, marshal, receiver, trustee in bankruptcy, or guardian) are exempt. These individuals are acting under court authority or legal obligation to manage and dispose of assets on behalf of others. The exemption reflects the fact that these sales are conducted under judicial or legal oversight, providing a separate layer of investor protection.

Transactions Pursuant to an Offer Directed to Not More Than a Limited Number of Persons

The USA exempts offers directed to a limited number of persons (typically no more than 10 offerees, though the exact number can vary by state) during a 12-month period, provided that the seller reasonably believes all buyers are purchasing for investment (not for resale), no commissions are paid for the solicitation, and no general advertising or solicitation is used. This is similar in concept to the federal private placement exemption.

Transactions Between Underwriters

Transactions between the issuer and an underwriter, or among underwriters, are exempt. This exemption exists because these transactions are part of the securities distribution process and do not involve sales to the investing public. Once the underwriter offers the securities to the public, however, the securities must be registered unless another exemption applies.

Private Placements and Regulation D

A private placement is an offering of securities that is not made to the general public. Private placements are one of the most important exemptions in securities law because they allow companies to raise capital without the time and expense of a full public registration. Under the USA, private placements may qualify for the limited offering exemption discussed above, but the most commonly used private placement exemptions come from federal Regulation D.

Regulation D Overview

Regulation D under the Securities Act of 1933 provides three exemptions from federal registration: Rule 504, Rule 506(b), and Rule 506(c). For Series 66 purposes, the most important is Rule 506, which is the primary exemption used for larger private placements.

Rule 506(b) allows an issuer to raise an unlimited amount of capital from an unlimited number of accredited investors and up to 35 non-accredited but sophisticated investors. General solicitation and advertising are prohibited. Non-accredited investors must receive disclosure documents substantially similar to what would be provided in a registered offering. All investors receive "restricted securities" that cannot be freely resold without registration or another exemption.

Rule 506(c), added by the JOBS Act of 2012, allows general solicitation and advertising, but all purchasers must be accredited investors, and the issuer must take reasonable steps to verify accredited investor status. This verification requirement goes beyond the self-certification allowed under Rule 506(b).

Rule 506 offerings are federal covered securities. Because they are conducted under Section 18 of the Securities Act of 1933, they are exempt from state registration. However, states may require a notice filing (Form D), a consent to service of process, and a fee. States cannot impose additional registration requirements on Rule 506 offerings, but they retain full anti-fraud authority.

Accredited Investors

An accredited investor under Regulation D includes the following categories:

Banks, insurance companies, registered investment companies, business development companies, and small business investment companies
Employee benefit plans with total assets exceeding $5 million, or plans directed by a bank, insurance company, or registered investment adviser
Charitable organizations, corporations, partnerships, or business trusts with total assets exceeding $5 million
Directors, executive officers, or general partners of the issuer
Natural persons with individual net worth (or joint net worth with a spouse) exceeding $1 million, excluding the value of the primary residence
Natural persons with individual income exceeding $200,000 (or joint income with a spouse exceeding $300,000) in each of the two most recent years, with a reasonable expectation of the same in the current year
Trusts with total assets exceeding $5 million, not formed for the specific purpose of acquiring the securities, and directed by a sophisticated person
Entities in which all equity owners are accredited investors
Knowledgeable employees of private funds (added by SEC amendment)
Holders of Series 7, Series 65, or Series 82 licenses in good standing (added by SEC amendment)

Feature	Rule 506(b)	Rule 506(c)
Amount Raised	Unlimited	Unlimited
Accredited Investors	Unlimited	Unlimited (ALL purchasers must be accredited)
Non-Accredited Investors	Up to 35 (must be sophisticated)	None allowed
General Solicitation	Prohibited	Permitted
Verification Required	Self-certification acceptable	Reasonable steps to verify status
Federal Covered	Yes	Yes
State Notice Filing	Required (Form D)	Required (Form D)

Administrator Authority Over Exemptions

The state Administrator has important powers regarding exemptions. Under the USA, the Administrator may by rule or order deny, suspend, or revoke any exemption (with the exception of certain enumerated exempt securities) if the Administrator finds that the application of the exemption is not in the public interest or is detrimental to investors. This means that even if a transaction technically qualifies for an exemption, the Administrator can withdraw the exemption if the circumstances warrant it.

The Administrator can also create additional exemptions by rule or order. This flexibility allows the Administrator to adapt to changing market conditions and new types of securities offerings. For example, many states have adopted exemptions for crowdfunding offerings that were not contemplated when the USA was originally drafted.

However, the Administrator cannot deny or revoke an exemption without providing notice and an opportunity for a hearing (except in emergency situations). The burden of proving that an exemption applies generally falls on the person claiming the exemption. If the exemption is lost (for example, because the conditions were not met), the transaction may be voidable, and the seller may be liable for rescission.

Exemptions are critical to the functioning of the securities markets. Exempt securities include government securities, bank securities, nonprofit securities, and federal covered securities. Exempt transactions include isolated non-issuer transactions, sales to institutional investors, unsolicited brokerage transactions, fiduciary transactions, and limited offerings. Private placements under Regulation D Rule 506 are federal covered securities. The Administrator can deny or create exemptions, but anti-fraud provisions always apply regardless of any exemption.

Deep Dive Resale of Restricted Securities (Rule 144)

Securities acquired in a private placement under Regulation D are restricted securities, meaning they cannot be freely resold in the public markets without registration or an exemption from registration. The most common exemption for reselling restricted securities is Rule 144 under the Securities Act of 1933.

Rule 144 allows holders of restricted securities to sell them in the public market if certain conditions are met. For securities of reporting companies (those that file reports with the SEC), the holder must wait a minimum of six months from the date of acquisition before selling. For securities of non-reporting companies, the holding period is one year.

After the holding period, the holder may sell the securities subject to certain volume limitations. Affiliates of the issuer (officers, directors, and 10% shareholders) are limited to selling the greater of 1% of the outstanding shares or the average weekly trading volume during the preceding four weeks. Non-affiliates who have held the securities for at least one year have no volume limitations.

Affiliates must also file a Form 144 with the SEC if the proposed sale exceeds 5,000 shares or $50,000 in value during any three-month period. The sale must be conducted through ordinary brokerage transactions, and the seller cannot solicit orders to buy the securities.

At the state level, the resale of restricted securities may qualify as an isolated non-issuer transaction or may fall under another state exemption. The specific requirements vary by state, but the fundamental principle is that restricted securities cannot be freely resold without satisfying both federal and state requirements.

Remember exempt transactions with "I U F I L": Isolated non-issuer transactions, Unsolicited brokerage transactions, Fiduciary transactions, Institutional investor transactions, Limited offering (private placement) transactions. Think: "I Usually Find It Logical" to remember these five key exempt transactions.

Check Your Understanding

Test your knowledge of exemptions from registration. Select the best answer for each question.

1. Which of the following securities is exempt from state registration under the USA?

2. An unsolicited brokerage transaction is exempt from registration because:

3. Under Rule 506(b) of Regulation D, how many non-accredited investors may purchase securities?

4. A natural person qualifies as an accredited investor under Regulation D if they have:

5. Anti-fraud provisions of the USA apply to: