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.
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. If the offering you are considering has prior sales, you can search for the Form D filing on the SEC’s website at sec.gov/edgar/searchedgar/webusers.htm.
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. 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.
The Private Placement Memorandum (“PPM”) serves to disclose critical information to potential investors ensuring they are properly informed regarding the company’s operations, investment risks, SEC disclosures, and offering terms prior to investing. A unique aspect of our offering documents is the “Presentation Grade” quality of the memorandum document. A private placement memorandum will also have Exhibits to disclose additional needed information critical to the investment decision such as historical and projected financials, subscription documents, related contracts, company bylaws, and other pertinent supporting data.
For offerings executed under certain Regulation D exemptions the SEC has specific regulations that govern what is disclosed to investors. Regulation D Resources has adopted the SEC’s Form 1A disclosure standard for use in crafting our Regulation D exempt private placement memorandum documents. The Form 1A standard is the disclosure standard and disclosure format the SEC mandates for certain registered type securities offerings and exceeds what is typically required under a Regulation D exempt offering. Drafting our PPM’s to this standard provides several important benefits to our clients:
• A properly prepared Form 1A spec private placement memorandum protects the client more effectively than the “letter” or summary type offering documents typically prepared by other Regulation D preparatory firms
• Form 1A provides for a very high specification private placement memorandum document which greatly enhances the professionalism of your disclosure package for investors
• Form 1A is the disclosure standard most broker-dealer firms will require in order to have the offering approved for retail to their investor clients
Points That You Should Be Mindful Of In Steering a Private Placement Transaction from Start to Finish
Understand the company’s goals and needs. Private placements, including private investments in public equities (PIPEs), provide companies with great flexibility, allowing them to issue a variety of instruments common or preferred equity securities, straight or convertible debt securities, warrants, units, and/or bespoke securities tailored to meet their particular financing needs. A company considering a private placement may not be familiar with the range of securities available and may not fully appreciate how a particular security fits within its existing capital structure. As a starting point, you should discuss with the company its strategic objectives for the proposed financing within the context of its existing capital structure and, within this framework, assist the company in deciding what type of security is best suited to the company’s goals and needs.
Find your U.S. federal securities law exemption for issuance and understand resale limitations.
Private placements occur within a complex and evolving regulatory framework of U.S. federal securities laws, stock exchanges’ rules, regulators’ interpretations, and companies’ own limitations under their existing capital structures. For purposes of U.S. federal securities laws, the fundamental principle is that a company may not offer or sell securities unless the transaction has been registered with the SEC or an exemption from registration is available. For a private placement to comply with the U.S. federal securities laws there must be a valid exemption from the registration requirements available, and the terms and execution of the proposed offering and sale must comply with the requirements of that exemption. You should engage in a collaborative exercise with the issuing company to identify the exemption that is best suited to the proposed transaction from the range of available exemptions, including, among others:
• Section 4(a)(2) exemption (Section 4(a)(2)) under the Securities Act of 1933, as amended, 15 U.S.C. § 77a et seq., (Securities Act)
• Safe harbors of Regulation D under the Securities Act
• Quasi-public offering structure of Regulation A (informally known as Regulation A+) under the Securities Act
• Crowd funding exemption under Section 4(a)(6) of the Securities Act (Section 4(a)(6))
• Exemption for private placements under Rule 144A of the Securities Act (Rule 144A)
• Offshore transaction exemption under Regulation S of the Securities Act
• Exchange offer exemption of Section 3(a)(9) of the Securities Act
In order to choose an appropriate exemption, it will be necessary to know various key facts, including the proposed size of the potential offering, identity of the potential investors (and how they will be identified), location of potential investors, whether an investment bank will be engaged to facilitate the offering and, if so, in what capacity, the nature and extent of the marketing and distribution process, and other factors.
How Private Placements are Governed
Private placements are not an asset class. They are a technique by which capital is raised from non-institutional private capital sources, mainly individuals. They can be used as a vehicle for investments in private equity, venture capital, and some tangible assets, for example.
A multitude of state and federal laws and regulations govern private placements, including:
• The Securities Act of 1933, which governs the issuance of securities by companies
• The Securities Exchange Act of 1934, which governs the trading, purchase and sale of those securities
• Regulations derived from the 1933 and 1934 Securities Acts, promulgated by the Securities and Exchange Commission especially Regulation D
• Regulations promulgated by the Financial Industry Regulatory Authority and the various stock exchanges
• State securities laws and regulations, known as blue sky laws, administered by the various state securities commissions.
Private Placement Securities
In a private placement, the shares of stock or debt instrument are considered securities under both federal and state securities laws. Consequently, any transaction involving the shares or debt must be registered under such securities laws or be exempt from registration. Typically, the offeror is an emerging growth company that has few capital alternatives, although more mature companies tend to be more successful in this process. Securities laws generally require that offers are made mainly to accredited investors.
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