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 reviewed by an attorney to find out whether a security is present in the transaction and if this securities exemption will be required to avoid registration or qualification. As equity interests need examining 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 are required to avoid registration or qualification. The proper use of securities exemptions are essential to:
- Legally raise capital from investors;
- Avoid criminal or civil liability for securities fraud; and
- Attract investors by providing all required documentation.
All offers or sales of securities must be registered under the Federal Securities Act of 1933 unless securities exemptions are available.
The following is not an exhaustive list of federal securities exemptions from under the Federal Securities Act of 1933 but includes the most used federal 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. 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 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 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 to find or organize 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 is 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 was enacted to provide a 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 Regulation D purposes, an accredited investor is a person who, at the time securities are sold to that investor, is: