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“Section 4(a)1(1/2)” Exemption for Resales of Restricted Securities Now Codified

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By Thomas R. Taylor, Esq.

A relatively obscure new federal statute entitled the Fixing America’s Surface Transportation Act, or the “FAST” Act, was signed into law on December 4, 2015.  While primarily related to improving transportation, the FAST Act amends Section 4 of the Securities Act of 1933 (the “Securities Act”) to provide for a new limited resale exemption intended to “enhance liquidity in the [private] market for company‑issued securities . . ..”  The FAST Act amended the Securities Act and adopted a new statutory exemption codified as Section 4(a)(7), which provides for private resales of restricted and control securities.  The House Report on the FAST Act notes that Section 4(a)(7) is intended to “increase market liquidity and resolve legal uncertainty that impedes employees of private companies from selling their company‑issued securities . . ..”

THE SECTION 4(1½ ) EXEMPTION

 New Section 4(a)(7) codifies the so‑called “Section 4(1½)” exemption under the Securities Act.  Section 4(a)(7) provides a statutory basis for resales of securities by persons other than the issuer, who heretofore relied on the “Section 4(1½)” private placement exemption, which is a case law‑developed exemption for the resale of privately placed securities.  (The so‑called “Section 4(1½)” exemption is not provided for in the Securities Act, but rather refers to transactions structured such that they comply with and rely on certain elements or principles required by Section 4(a)(1) and Section 4(a)(2) of the Securities Act and provide for an amalgamation of certain of the principles required by those two statutory provisions.)  While not formally provided for by the Securities Act, the “Section 4(a)(1½)” exemption has been relied on and used by securities lawyers and has developed through case law and judicial interpretation, and been recognized by the Securities and Exchange Commission (the “SEC”) for years.  While new Section 4(a)(7) codifies the registration exemption colloquially referred to as “Section 4(a)(1½)”, the FAST Act makes it clear that Section 4(a)(7) does not replace the “Section 4(a)(1½)” exemption.  Therefore, the “Section 4(a)(1½)”exemption can still be relied upon if wanted.

Under U.S. securities law, securities may be offered and sold only pursuant to a registration statement filed with the SEC under the Securities Act or pursuant to an exemption from registration.  The Securities Act and various Regulations thereunder provide for several registration exemptions, most notably Section 4(a)(1) (which applies to transactions by a person other than an issuer, underwriter or dealer) and Section 4(a)(2) (which applies to transactions by an issuer not involving a public offering).  However, neither of those statutory provisions, nor the related safe harbors provided under Rule 144 and Regulation D, provide a specific exemption for the private resale of previously issued securities.  Instead, sellers have historically relied on the “Section 4(a)(1½)” exemption.

NEW SECTION 4(a)(7) EXEMPTION

New Section 4(a)(7) of the Securities Act exempts from registration a private resale of securities by persons other than the issuer who meet the following requirements:

  • Accredited Investors‑‑Each purchaser must be an “accredited investor” within the meaning of Regulation D;
  • No General Solicitation or Advertising‑-Neither the seller, nor anyone acting on the seller’s behalf, can use any general solicitation or advertising in offering or selling the securities;
  • Non‑Reporting Company Information Requirement‑‑Issuers who are not subject to SEC reporting requirements or not exempt from reporting under Rule 12g3‑2(b) of the Securities Exchange Act of 1934 (the “Securities Exchange Act”) must provide the seller and prospective purchaser with certain information, including the following:  (a) the name and address of the issuer and the nature of its business; (b) the title and class of the securities and the total number of shares outstanding; (c) the identity of the issuer’s officers and directors; (d) the issuer’s most recent balance sheet and profit and loss statement and “similar financial statements” for the two preceding fiscal years (each of which must be prepared in accordance with generally accepted accounting principles); and, (e) if the seller is a control person of the issuer, a brief statement of the nature of the affiliation and a certified statement by the seller that such seller has no reasonable grounds to believe the issuer is in violation of any applicable securities laws or Regulations;
  • Bad Actor Prohibition‑‑Neither the seller, nor any person receiving a commission for participating in the transaction, is disqualified as a “bad actor” under Rule 506(d)(1) of Regulation D or subject to disqualification under Section 3(a)(39) of the Securities Exchange Act;
  • Business Requirement‑‑The issuer must be engaged in a business that is not in the organizational stage or in bankruptcy, and cannot be a blank check, blind pool or shell company;
  • Underwriter Prohibition‑‑The transaction cannot involve securities that are part of an unsold allotment to an underwriter; and
  • Outstanding 90 days‑‑The securities to be resold must have been authorized and outstanding for at least 90 days prior to their resale.

The adoption of new Section 4(a)(7) is significant because it provides a statutory basis for private resales of restricted and control securities.  Accordingly, Section 4(a)(7) provides a higher degree of certainty that securities sold in private resale transactions will be exempt from the registration requirements of the Securities Act than has been provided historically under the “Section 4(a)(1½)” exemption.

KEY TAKEAWAYS

  • The FAST Act adds a new exemption from SEC registration that is intended to facilitate resales of securities issued in the private market
  • New Section 4(a)(7) exempts from registration private resales of securities by persons other than the issuer or a subsidiary, provided that the resale process meets certain requirements
  • Section 4(a)(7) does not replace the “Section 4(a)(1½)” exemption; therefore, the “Section 4(a)(1½)” exemption procedures continue to be available for sellers who either are unwilling or unable to comply with the requirements of new Section 4(a)(7)
  • Securities acquired in reliance on Section 4(a)(7) will be deemed to be acquired in a transaction not involving a public offering and not to be part of a distribution
  • Such securities will be deemed to be “restricted securities” within the meaning of Rule 144
  • such securities will be “covered securities” within the meaning of Section 18(b) of the Securities Act and, therefore, exempt from state securities or “blue sky” registration requirements

This article is intended for educational and informational purposes only and is not intended to, and should not be construed as, legal advice.  Readers should consult their own lawyer regarding the applicability of the information discussed in this article to their particular situation and facts.

Thomas R. TaylorThomas R. Taylor explains why exemption for resales of restricted securities is now codified is a corporate, corporate finance and M&A lawyer and a shareholder in the Salt Lake City office of Durham, Jones & Pinegar, P.C.  Tom is listed as one of the leading corporate and M&A lawyers in the United States by both Chambers & Partners and Super Lawyers, as one of the Best Lawyers in American in Corporate Law and M&A Law by Best Lawyers, as a Top Attorney in Utah, Nevada, Montana, Idaho and Wyoming in Mergers & Acquisitions by American Registry, LLC, and as one of the leading M&A, corporate and transactional lawyers in the State of Utah by Utah Business magazine.  He maintains an “AV” rating with Martindale‑Hubbell, which is the highest rating awarded to attorneys for professional competence and ethics.  Tom can be reached at (801) 297‑1370 (o) or (801) 891‑6145 (c) or at ttaylor@djplaw.com.