December 2, 2020

Volume X, Number 337


December 02, 2020

Subscribe to Latest Legal News and Analysis

December 01, 2020

Subscribe to Latest Legal News and Analysis

November 30, 2020

Subscribe to Latest Legal News and Analysis

Private Placements: Exemption and Disclosure Issues


The following outline provides an overview of the private offering and resale exemptions available to issuers and investors under the Securities Act of 1933 (the "Securities Act"). The private offering exemption in particular has increasingly been used for offerings of novel or complex securities and during times of market downturns and market uncertainties.


The term "public offering" is not defined in the Act. The contours of the non-public offering exemption have been established by interpretations of the Act by the Securities and Exchange Commission (the "SEC") and the courts.

In Securities Act Release No. 33-285 (January 24, 1935) the SEC indicated that the following four factors should be considered in determining whether an offering is public:

  • The number of offerees and their relationship to each other and to the issuer. The focus is on the number of offerees, not the actual purchasers. The basis on which the offerees are selected and the relationship between the issuer and the offerees are significant. An offering to the members of a class who should have special knowledge of the issuer is less likely to be a public offering than an offering to the same number of persons who do not have that advantage.
  • The number of securities offered.
  • The size of the offering.
  • The manner of offering. Transactions which are effected by direct negotiation by the issuer are more likely to be considered non-public than those effected through the use of the mechanisms of public distributions.

Absent an exemption from registration, every securities transaction that uses the U.S. mails or other means of interstate commerce must be registered with the U.S. Securities and Exchange Commission. The most common securities laws issuer exemptions under the Securities Act are the following:

  • Section 4(2);
  • Section 4(6);
  • Regulation D, including Rules 504, 505, and 506;
  • Regulation S; and
  • Rule 701.

Of these, the issuer "private offering" exemptions are:

  • Section 4(2) of the Securities Act, which provides a statutory exemption for "transactions by an issuer not involving any public offering."
  • Rule 506 of SEC Regulation D, which provides a regulatory safe harbor for an issuer engaged in a non-public offering. A copy of Regulation D is attached.

The issuer must, in either instance, demonstrate that the offering (a) meets the requisite offeree/purchaser qualification requirements and informational requirements, (b) should not be integrated with another exempt or registered offering, (c) does not involve any general solicitation or advertisement, and (d) includes appropriate resale restrictions.

The securities issued and sold to purchasers are so-called "restricted" securities. There are at least six ways for investors to resell in a single transaction the restricted securities received in a private placement:

  • register the securities (e.g., in the "public equity" side of a PIPE transaction);
  • sell the securities directly to qualified institutional buyers ("QIBs") pursuant to SEC Rule 144A;
  • resell the securities through an offshore transaction pursuant to the resale provisions of SEC Regulation S;
  • sell the securities to the public in a transaction not involving a distribution as defined by SEC Rule 144;
  • sell the securities pursuant to the SEC Rule 144(k) (fully available to non-affiliates after two (2) years); and
  • sell the securities in a "4(1 and 1/2)" transaction.

Hereinafter all regulations and rules are as promulgated by the Securities and Exchange Commission unless otherwise indicated.

I.    Section 4(2) and Rule 506 Requirements

A.    Exemptions Only For Issuers

  • Section 4(2) and Rule 506 are limited to offerings by an issuer; resales by underwriters and affiliates of an issuer must rely on another exemption.

B.    Only Qualified Offerees

  • Section 4(2) private offering: Limited to persons capable of fending for themselves. See SEC v. Ralston Purina, 246 U.S. 119 (1953) ("Ralston Purina"). In Ralston Purina the Supreme Court addressed the Section 4(2) exemption. It remains the only Supreme Court interpretation of this exemption.
    • Unlike the earlier SEC Release, the Court did not focus on the "quantity" of offerees involved but instead focused on the "quality" of those persons. The Court stated that "nothing prevents the [SEC], in enforcing the statute, from using some kind of numerical test in deciding when to investigate particular exemption claims. But there is no warrant for superimposing a quantity limit on private offerings as a matter of statutory interpretation." Id. at 125.
    • The Court stated that the "design of the [Act] is to protect investors by promoting full disclosure of information thought necessary to informed investment decisions. . . [T]he applicability of [§4(2)] should turn on whether the particular class of persons affected needs the protection of the Act." Id. at 124-25.
    • The Court noted that an offering to persons who are shown to be able to "fend for themselves" is a transaction not involving any public offering. In determining whether a person is capable of fending for himself, the Court appeared to be concerned with whether the offeree (1) had access to the kind of information which registration would disclose and (2) was financially sophisticated.
    • In Lively v. Hirschfeld, 440 F.2d 631, 633 (10th Cir. 1971), the Court of Appeals limited the private offering exemption to include "only persons of exceptional business experience, and [those in] a position where they have regular access to all the information and records which would show the potential for the corporation." In SEC v. Continental Tobacco, 463 F.2d 137 (5th Cir. 1972), the Court required the issuer to prove that each offeree had a relationship with the issuer giving access to the kind of information that registration would have disclosed. In Doran v. Petroleum Management Corp., 545 F.2d 893, 903 (5th Cir. 1977), the Court determined that access to information about the issuer can be provided either through direct disclosure to the offeree or by means of effective access through family relationship, employment or economic bargaining power.
  • Rule 506 safe harbor: Need to ensure that the offering is made to accredited investors and not more than thirty-five (35) sophisticated investors.
    • The definition of accredited investor is outlined in Rule 501(a). The concept of "accredited investor" is critical in the private offering context, both from the standpoint of establishing an exemption for the offers and sales and in determining the required level of disclosure as discussed below. An accredited investor means any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:
      • SP a bank, insurance company, registered investment company, business development company, or small business investment company;
      • an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decision, or if the plan has total assets in excess of $5 million;
      • a charitable organization, corporation, or partnership with assets exceeding $5 million;
      • a director, executive officer, or general partner of the company selling the securities;
      • a business in which all the equity owners are accredited investors;
      • a natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase;
      • a natural person with income exceeding $200,000 in each of the two most recent years of joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
      • a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
    • Neither Section 4(2) nor Rule 506 (other than the thirty-five (35) sophisticated investor limit) contains any numerical caps on the number of offerees and purchasers. The general solicitation prohibition and market practice typically set the outer parameters.

C.    Information Disclosure Requirements

Section 4(2) and Rule 506 contain informational requirements. If a disclosure obligation exists, the information must be provided to the offeree prior to the time of sale.

  • Section 4(2): Each offeree must possess or have access to the type of information that would be included in a registration statement and which would enable the offeree to make an informed investment decision. In Sorrell v. SEC, 679 F.2d 1323 (9th Cir. 1982), the Court focused on both "quantity" and "quality" of offerees and stated that the private offering exemption under Section 4(2) depended on the number of offerees, their sophistication, the size and manner of the offering and the relationship of the offerees to the issuer. In holding that Sorrell failed to meet his burden that the sale of 16 limited partnership interests was exempted from registration, the Court noted that access by the offerees to financial information about the investment, similar to what would be found in a registration statement, would be "crucial." At trial, Sorrell offered no evidence of the number of offerees and no evidence of the information they received. Such information generally includes information concerning the issuer's business, financial condition, results of operations, property, and management.
  • Rule 506: (i) There are no informational requirements for accredited purchasers. The rationale is that these investors are sophisticated and have sufficient bargaining power to obtain all relevant information from the issuer. However, SEC Rule 10b-5, promulgated pursuant to the Securities Exchange Act of 1934 (the "Exchange Act"), which imposes liability for material misstatements or omissions, still applies to sales of securities to all offerees, including these accredited investors. (ii) Each non-accredited purchaser (i.e. the 35 sophisticated investors) must receive certain information, which varies based on the nature of the issuer and the size of the offering.
  • Non-Reporting Issuers: Must provide each purchaser with certain non-financial information and with specific types of financial statement information depending upon the size of the offering. See Rule 502(b).
    • Reporting Companies:
      • Reporting companies must furnish the same disclosure, regardless of offering size. Such information may either be:
        • (a)    An issuer's most recent annual report to shareholders that meets the requirements of Exchange Act Rule 14a-3 (which specifies the information required to be delivered in connection with proxy solicitations) or Rule 14c-3 (annual report information requirements delivered in non-proxy solicitations prior to an annual meeting or other shareholder meeting), the definitive proxy statement filed in connection with that annual report, and, if requested in writing, the issuer's most recent Form 10-K.
        • (b)    The information contained in the issuer's most recent annual report on Form 10-K or a Form 10 under the Exchange Act or a Form S-1 under the Securities Act. Under this option, the actual form documents need not be delivered because the relevant rule refers to the information contained in the forms, not the forms themselves.
      • An issuer is obligated to update and supplement any such disclosures with additional information and must provide disclosures regarding material changes in the issuer's affairs that are not covered in documents furnished to purchasers.
    • Foreign Private Issuers: Financial statements of foreign private issuers may be prepared using U.S. generally accepted accounting principles ("U.S. GAAP") or non-U.S. GAAP statements, provided the statements are reconciled with U.S. GAAP.

II.    Integration Issues In Private Placements

A.    Integration Doctrine

  • The doctrine is intended to prevent issuers from circumventing the registration requirements of the Securities Act and is used to determine whether:
    • two or more purportedly discrete exempt offerings are really one offering that does not qualify as an exempt offering, or
    • an exempt offering is really part of a registered public offering.

B.    Integration Analyses

  • Five factor test
    • Securities Act Release No. 33-4552 (Nov. 6, 1962) sets forth the five factor test that is used as a guideline in determining whether or not the separate offerings of an issuer that occur within a short time of one another will be integrated. The same factors are in the Note to Rule 502(a) of Regulation D. The factors considered are:
      • (a)    whether or not the offerings are part of a single plan of financing;
      • (b)    whether the offerings involve the issuance of the same class of securities (convertible securities, warrants, and other derivative instruments generally are deemed to be the same class as the underlying security unless the terms of the primary security prohibit exercises until at least the one year anniversary date);
      • (c)    whether the offerings are made at or about the same time;
      • (d)    whether the same type of consideration is to be received; and
      • (e)    whether the offerings are made for the same general purpose.
  • Practitioners should also consider a sixth factor: Are the offerees in each offering of the same class or character?
  • The five factor test has not brought certainty to the area because its application is subjective and the staff has not provided definitive guidance as to what weight to give to the various factors or indeed how many of them have to be met. See Sonnenblick, Parker & Selvers (avail. Jan. 1, 1986).
    However, there is no guidance as to how many of the five factors must be satisfied. In Sonnenblick, the staff stated that it considered the two most important factors to be (a) whether the financings constituted a single plan of financing, and (b) whether the offerings were for the same general purpose.
  • In NABA Sports Corp.; North American Baseball Association, Inc. (avail. Sept. 9, 1987), the staff considered whether simultaneous offerings of different securities by the same issuer were to be treated as part of the same offering. The staff concluded that a Rule 504 offering of Class A common stock to raise start-up money need not be integrated with a Rule 506 offering of options to purchase Class B common stock made to selected investors to solicit interest in becoming team owners in the baseball league. The staff stated that the offerings appeared to involve different securities because "the Class B common stock will be non-transferable, have liquidation preference and contain a limited forfeiture provision" and the offerings appeared to be for different purposes.
  • In Monitrend Investment Management, Inc. (avail. May 3, 1988), the staff determined that a public offering of common stock and preferred stock did not need to be integrated with a private placement of notes and common stock purchase warrants made less than six (6) months later. The staff concluded that the offerings "appear to involve different classes of securities" (the common stock purchase warrants were not exercisable and generally were nontransferable for a period of five (5) years), and the offerings "appear to be for different purposes and involve different plans of financing." The proceeds of the note and warrant offering were to be used for acquisitions.
  • In Anthem Insurance Companies, Inc. (avail. Oct. 25, 2001), the staff found that a proposed demutualization converting the company from a mutual insurance company into a stock insurance company and the distribution of common stock in connection with the demutualization should not be integrated with a coincident IPO. The staff, in applying the five factor test, found that the demutualization and the IPO were not part of the same plan of financing nor were the offerings made for the same general purpose. The two events had two (2) separate goals: the demutualization to provide the company with greater financial flexibility and the IPO to raise capital for the Company. See also The Prudential Insurance Company of America (avail. April 6, 2001).
  • Six-month safe harbor
    • Rule 502(a) provides that multiple private offerings that are conducted at least six (6) months apart will not be integrated; also, a private offering that is conducted at least six (6) months before or after a registered or exempt public offering will not be integrated with the public offering.
  • Rule 152
    • Rule 152 and staff interpretations provide that an otherwise valid private placement will not be integrated with a subsequent registered public offering. See, e.g., Verticom, Inc. (avail. Feb. 12, 1986); Vulture Petroleum Corporation, (avail. Feb 2, 1987); Quad City Holdings Inc., (avail. Apr. 8, 1993).
    • The closing date for the private offering may occur after filing of the registration statement so long as all closing conditions, other than customary conditions such as no material adverse change, are outside the control of the private investors.
  • Black Box/Squadron Ellenoff Policy Positions
    • In Black Box Incorporated, the SEC stated that, pursuant to Rule 152, a private placement is completed on the date the agreement to purchase securities is signed provided the purchaser's obligations are binding and subject only to satisfaction of conditions that are not within the purchaser's control. In Squadron, Ellenoff, Pleasant & Leher, the SEC cautioned that the position taken in its Black Box no-action letter is limited to unregistered offerings made to Rule 144A qualified institutional investors and no more than two or three large institutional accredited investors. See Black Box, Inc., (avail. June 26, 1990) and Squadron, Ellenoff, Pleasant & Lehrer (avail. Feb. 28, 1992).
  • Rule 155 Safe Harbors for Abandoned Private and Public Offerings (Release No. 33-7943, effective Mar. 7, 2001)
    • General:
      • The Rule creates safe harbors to allow (i) a public offering immediately following an abandoned private offering and (ii) a private offering thirty (30) days after an abandoned public offering, without integrating the public and private offerings in either situation.
      • These safe harbors provide issuers with more flexibility to react to volatile capital market conditions.
      • The safe harbors will not be available if the Commission finds that transactions, while technically in compliance, are part of a plan or scheme to evade the registration requirements of the Securities Act.
      • Rule 155 does not replace the traditional integration analysis and in that respect, the traditional five factor test will be used whenever the safe harbor specifications are not met.
      • Rule 155 does not address whether two or more private offerings should be integrated with each other. The traditional five factor test would apply to this scenario.
      • Rule 155 recognizes only Sections 4(2) and 4(6) (which exempts transactions not exceeding $5 million if offers and sales are made only to "accredited investors" as defined in Section 2(a)(15) of the Securities Act and Rule 215 and if certain other conditions are met) and Rule 506 offerings as exempt offerings.
      • Rule 155 is not available for shelf registration statements.
    • The Rule 155(b) safe harbor for abandoned private offerings is available if:
      • no securities were sold in the private offerings;
      • the issuer or its intermediary terminates all offering activity in the private offering before the issuer files the registration statement (proof of which the Commission has encouraged the staff to monitor closely to avoid abuse of Rule 155(b));
      • any prospectus filed as a part of the registration statement discloses information about the abandoned private offering including (a) the size and nature of the private offering, (b) the date on which the issuer terminated all offering activity in the private offering, (c) that any offers to buy or indications of interest in the private offering were rejected or otherwise not accepted, and (d) that any prospectus delivered in the registered offering supersedes any selling materials used in the private offerings; and
      • the issuer does not file the registration statement for a period of thirty (30) calendar days from termination of offering activity related to the abandoned private offering; there is no waiting period if offers in the private offering were made only to accredited or sophisticated investors.
    • The SEC has instituted several measures to prevent the use of the Rule 155(b) safe harbor to facilitate any intentional "gun jumping," by which an issuer distributes offering materials and solicits offers before a registration statement is filed.
      • Any issuer that relies on the Rule 155(b) safe harbor must first satisfy the private offering exemption (i.e., the private offering must be bona fide). Rule 155 defines a private offering as an unregistered offering of securities that is exempt from registration under Section 4(2) or 4(6) of the Securities Act or Rule 506 of Regulation D. This requirement is intended to insure that the initial private offering is a serious offering by the issuer and that the issuer initially has the intention to consummate the offering when commenced.
      • The SEC has stated that it intends to closely monitor the use of Rule 155(b) to prevent its misuse and the Staff has the authority to request additional information from the issuer regarding the termination of all offering activity in the private placement.
      • Any issuer that, although in technical compliance, intends to use either of the Rule 155 safe harbors as a plan or scheme to evade the registration requirements under the Securities Act will be denied the right to use the safe harbor. These measures are designed to insure that any gun jumping that may occur as a result of the utilization of Rule 155(b) is incidental to a bona fide private offering and not a plan to avoid the gun jumping restrictions of the Securities Act.
    • Rule 155(c) safe harbor for abandoned public offerings is available if:
      • no securities were sold during the registered offering. (This requirement will not be met if the issuer or its intermediary received any money or other form of consideration, including escrowed monies, for the securities);
      • the issuer withdraws the registration statement. See Rules 477 and 478 under the Securities Act:
      • the issuer and its intermediary do not commence the private offering earlier than thirty (30) calendar days after the effective date of withdrawal of the registration statement;
      • the issuer notifies each offeree in the private offering that the offering is not registered under the Securities Act and of the consequences that accompany a private placement, which include informing the investor that (a) the securities are restricted securities that can not be resold without registration unless an exemption is available and (b) purchasers do not have the protection of Section 11 of the Securities Act, which imposes civil liabilities on issuers on account of false registration statements; a registration statement for the abandoned public offering was filed and withdrawn;
      • any disclosure document used in the private offering discloses any changes in the issuer's business or financial condition that occurred after the issuer filed the registration statement and that are material to the investment decision in the private offering.
    • Under Rule 155(c), general solicitations occurring prior to the commencement of a 30-day cooling-off period do not affect the subsequent private offering. However, the private placement must otherwise be free of general solicitations and must otherwise qualify for an exemption from registration under Section 4(2) or 4(6) of the Securities Act or Rule 506 of Regulation D. In the SEC's view, this requirement will ensure that the private offering following the abandoned public offering is a bona fide private offering. The ban on general solicitations in private placements has not been lifted. However, in the SEC's view, a 30-day cooling-off period cures the impact of impermissible solicitations.
    • Other Integration Positions
      • Rule 701(f) that separates out employee benefit plans;
      • Preliminary Note 7 to Regulation D and the note to Rule 502(a), as well as Release No. 33-6863 (Apr. 24, 1990), providing that offshore offerings under Regulation S generally will not be integrated with domestic offerings;
      • ING Bank, N.V. (avail. July 8, 2002), providing that a onshore private offering of short-term paper conducted in compliance with Rule 506 of Regulation D should not be integrated with an offshore public offering carried out under Regulation S;
      • Rule 144A(e), stating that resales to QIBs pursuant to Rule 144A will not affect the availability of a prior or subsequent exempt offer or sale by an issuer or investor;
      • Rule 147's six month intrastate offering safe harbor.

III.    General Solicitation Issues

A fundamental premise of a private placement is the prohibition of general solicitation and advertising. "Negotiations or conversations with or general solicitations of an unrestricted and unrelated group of prospective purchasers for the purpose of ascertaining who would be willing to accept an offer of securities is inconsistent with a claim that the transaction does not involve a public offering even though ultimately there may only be a few knowledgeable purchasers." Securities Act Release No. 33-4552 (Nov. 6, 1962).

  • The prohibition applies to both issuers and anyone acting on behalf of the issuer. Rule 502(c) precludes the use of:
    • any advertisement, article, notice or other communication published in any newspaper magazine, or similar media or broadcast over television or radio, and
    • any seminar or meeting whose attendees have been invited by any solicitation or general advertising.
  • To avoid engaging in a general solicitation, one should:
    • look to the existence of a substantive relationship that evidences a person's investment sophistication. See, e.g., E.F. Hutton & Co. (avail. Nov. 3, 1985) (finding that broker dealers could ensure Rule 502(c) compliance by establishing a substantive and preexisting relationship with the offerees.) and
    • use third-party QIB lists.
  • The Commission does not condone the practice of investor "self-certification" of accreditation of sophistication prior to gaining access to a private offering.

A.    No General Solicitations

Commission interpretations indicate the following:

  • A broker dealer or issuer using an internet website can ensure compliance with Rule 502(c) by establishing a substantive relationship.
    • A pre-existing relationship may be established if (1) the issuer or broker dealer gathers information on a potential investor by means of a generic questionnaire that does not refer to a specific transaction, (2) a password protected page containing offerings is only available to a particular investor after the issuer or affiliated broker dealer determines an investor is sophisticated or accredited, (3) a potential investor can purchase securities only after the investor is qualified by the issuer or affiliated broker dealer as accredited or sophisticated, and (4) "period of time" must pass after this investor is qualified. See, e.g., IPONET (avail. July 26, 1996); Lamp Technologies (avail. May 29, 1997) (SEC recognized 30 day waiting period after the qualification of investors).
  • The mere fact that solicitations are directed to accredited investors may be insufficient to prove that solicitations are limited if no safeguards are taken to ensure that non-accredited offerees are not solicited. See In re CGI Capital Inc., Securities Act Release No. 33-7904 (Sept. 29, 2000) ("CGI Capital"). In CGI Capital, the company sent e-mail messages to several thousand potential investors regarding a private placement offering but failed to establish any pre-existing relationship with some of the investors contacted and failed to verify adequately the sophistication of the investors contacted. The company also provided an e-mail password to the investors contacted which granted access to the private offering website. The e-mail containing the password did not restrict those contacted forwarding the password nor did it warn those contacted about he restricted use of the password. Consequently, given CGI's failure to verify the sophistication or accreditation of its purchasers and given the forwarding of the password, the Commission found the company had engaged in a general solicitation in violation of Rule 502(c).

B.    Exceptions to the Prohibition Against General Solicitations.

  • Rule 135c: Rule 135c provides a safe harbor for an issuer's announcement of offerings not registered or not required to be registered under the Securities Act. Domestic and foreign reporting issuers and foreign companies claiming an exemption from the Exchange Act reporting requirements pursuant to Rule 12g3-2(b) may claim the safe harbor if:
    • (a)    the announcement contains a legend stating that the securities have not been registered and may not be sold in the United States absent registration or an exemption from registration, and
    • (b)    the announcement only includes the (i) the name of the issuer, (ii) the title, amount, and basic terms of the securities offered, the amount of the offering made by selling security holders, the time of the offering, and a brief statement of the manner and purpose of the offering, without naming the underwriters, and (iii) any statement or legend required by foreign or state law or administrative authority. In addition, other information must be included in the case of rights offerings, exchange offerings, and offerings to employees.
  • Rules 138 and 139: Rule 138 provides a research safe harbor for publication of research on an issuer's common stock where the issuer proposed to offer non-convertible debt or non-convertible, non-participating preferred stock and vice versa, if the research is distributed by a broker or dealer in the regular course of its business. Rule 139 allows publication and distribution of reports by a broker or dealer even if such reports are related to securities being offered and even if the broker or dealer is or will be a participant in the distribution of the securities to be registered.

C.    Regulation FD and General Solicitations

On October 23, 2000, the SEC's fair disclosure rules in Regulation FD become effective. Publicly reporting issuers must consider the rules in connection with general solicitation matters. Unlike registered public offerings, there is no carve-out for private offerings. See, e.g., Securities Act Release No. 33-7881 (Aug. 21, 2000).

  • Regulation FD mandates an issuer, or a person acting on its behalf, to disclose to the public material, nonpublic information that an issuer has provided to securities market professionals or holders of the issuer's securities whenever it is reasonably foreseeable that the security holder will trade on the basis of that information. The required disclosure may be made by filing a Form 8-K or by methods such as Internet webcasting or teleconferencing that are reasonably designed to effect broad, non-exclusionary distribution of the information to the public.
  • Disclosure of non-public information by public companies involved in a private offering is not exempted from Regulation FD.
  • Measures that may be taken to ensure compliance with Regulation FD while preserving a private exemption may consist of the following:
    • advise the issuer to limit the information it decides to make public at road shows in connection with a private placement (i.e., avoid disclosure of material, non-public information);
    • advise the issuer that it may be able to use information walls;
    • depending on the type of issue, encourage an issuer to enter into a FD compliant confidentiality agreement whereby the purchaser agrees not to trade in the issuer's securities until the non-public information becomes public (typically, however, investors are very reluctant to sign such agreements);
    • prior to alerting the broker dealer's sales force, advise the issuer to issue a press release disclosing the transaction, and
    • encourage broker dealers to make public any material information prior to the offering. Although general solicitation concerns are implicated with the issuance of news releases, the SEC has indicated that if the information is required for FD purposes and is of the kind that is told to stockholders, then the Commission will consider whether or not to classify the release as a general solicitation.

IV.    Limitation on Resales of Securities Sold in Private Placements and Some Strategies Used to Resell

To repeat, precautions that issuers typically take to prevent premature sales and the loss of the private offering exemption include:

  • making a reasonable inquiry to determine if the purchaser is acquiring the securities for its own account or on behalf of others including obtaining a written representation from the purchaser;
  • making a written disclosure to each purchaser prior to sale as to the absence of registration and to the restrictions on resale, and
  • placing legends on the certificate for the securities as to the absence of registration and restrictions on transfers (i.e., stop-transfer orders).

See also Securities Act Release No. 5121 (Dec. 30, 1970).

A.    Resale Strategies

  • Rule 144
    • allows sales of restricted securities by any affiliate of an issuer, any person selling for his/her own account the securities purchased from an issuer, or any person selling for the account of an affiliate of an issuer. Sales by such persons are not deemed a "distribution" of securities and the sellers are not categorized as Section 2(11) underwriters if all of the terms and conditions of the rule are met;
    • mandates a minimum of a one year holding period before the restricted securities may be "dribbled out." After two years, Rule 144 allows non-affiliates to freely resell. The manner in which the holding period is calculated and the "tacking" of holding periods in certain cases for holders who acquired certain types of securities is outlined in the rule;
    • limits the amount of securities sold to the greater of one percent of the class outstanding or, if traded on an exchange, the average weekly volume on all such exchanges during the four weeks preceding a sale transaction;
    • prohibits the sale of securities by the seller. Rather, the securities can only sold in "brokers' transactions" as defined in Section 4(4) of the Securities Act or transactions involving a market maker as defined in Section 3(a)(38) of the Exchange Act, and
    • mandates that adequate information regarding the issuer of the securities being sold is made publicly available.
  • "Exxon Capital" A/B Exchange Offers
    • An Exxon Capital A/B exchange offer refers to the practice whereby an issuer performs a private placement and, within a short time after completion of the private placement, effects a registered exchange offer for the securities previously offered in the private placement. The practice, therefore, results in the exchange of the restricted securities for freely tradable securities.
      • The procedure is only available for non-convertible debt securities, certain types of preferred stock and initial public offerings of common stock of foreign issuers to eliminate the Rule 144A facility
      • The staff positions are set forth in Exxon Capital Holding Corp. (avail. May 13, 1988), Morgan Stanley & Co. Incorporated (avail. June 5, 1991), Mary Kay Cosmetics, Inc. (avail. June 5, 1991) Epic Properties, Inc. (avail. Oct. 21, 1991), Vitro, S.A. (avail. Nov. 19, 1991), Corimon C.A.S.A.C.A. (avail. May 14, 1993) and Brown & Wood LLP (avail. Feb. 7, 1997), and Shearman & Sterling (avail. July 2, 1993).
    • Registration Rights (Demand and Piggyback)
    • Regulation S
      • The SEC has also recognized a non-statutory "exemption" for securities offered and sold outside the United States. Regulation S, Securities Act Release No. 33-6863 adopted in 1990, provides non-exclusive safe harbors for (x) offers and sales by issuers, distributors and their affiliates and (y) resales by others. In general, in order to qualify, (i) there must be an "offshore transaction" (i.e., an offer cannot be made to a person in the United States and the buyer must be outside the United States or the seller must reasonably believe the buyer is outside the United States) and (ii) neither the issuer nor any distributor (or any affiliate of either) may engage in any "directed selling efforts" (i.e., activities that may condition the United States market for the securities). In addition, for many offerings (i) there was a distribution compliance period during which no offer or sale may be made to a U.S. person for forty (40) days or, in some cases, for one year, and (ii) the offering documents and underwriting agreements must reflect certain restrictions on sales to U.S. persons.
      • In February 1998, the SEC adopted amendments to Regulation S designed to prevent perceived abusive practices in connection with offerings of equity securities to domestic issuers. Securities Act Release No. 33-7505 (Feb. 17, 1998). In addition to extending the distribution compliance period to one year for such securities (and requiring purchasers to agree that hedging transactions with respect to such securities will be conducted in compliance with the Securities Act), the amendments classify such securities as "restricted securities" under Rule 144. As a result, for such securities to be resold in the United States or to United States persons without registrations, the requirements of Rule 144 must be met, including the one year/two year holding period.

V.    State Law Issues

  • National Securities Markets Improvement Act of 1996 ("NSMIA"):
    • preempts state registration and review of transactions involving seven classes of "covered securities."
    • Rule 506 offerings preempt state securities laws except for applicable mandated notice and fee requirements.
    • Offerings effectuated pursuant to Section 4(2) do not preempt any state laws. Among other things, issuers should consider including in any Internet site legend containing an offering of securities, a general legend that alerts viewers that no offers or sales will be made in any jurisdiction in which such offers or sales are not qualified or otherwise exempt. In my experience, particular concern should be taken when privately offering securities in New York and California.
    • On December 19, 2001, the SEC in Release No. 33-8041 proposed that the term "qualified purchaser" as used in NSMIA be defined to mean an accredited investor as defined in Rule 501(a) of Regulation D.
  • Issuers should review NSMIA and the securities laws of the states into which offers or sales of securities are made and/or take the necessary precautions to ensure compliance with such laws. As one noted commentator has written, "Attempts to achieve uniformity in state law unfortunately thus far have been largely unsuccessful . . . NSMIA preempted some state blue-sky regulations, but it has served chiefly to benefit large businesses. The system of dual regulation is inherently discriminatory, subjecting small businesses to up to 51 different sets of laws and regulations, while large corporations face only one." Douglas R. Wright, "How Do I Tell My Story To Interested Investors And Not Get Sued," Venture Capital Financing CLE International, Denver, Colorado, April 26, 2002.
  • States retain the authority to investigate and bring anti-fraud proceedings.


In the opinion of the SEC and the courts, the factors relevant to the availability of the private placement exception to issuers under Section 4(2) of the Act include the number of offerees, the relationship of the offerees to the issuer, the relationship of the offerees to each other, the sophistication of the offerees, the value of the offering, the number of securities of fund, the monies in which the offer to sell if conveyed, and whether the securities have come to rest with the purchaser, as opposed to their further distributions. Integration issues among discrete private offerings remain subjects of concerns for issuers which can be overcome through reliance under SEC rules and "safe harbors", including, but not limited to, Rules 135, 138, 139, 144, 144A, 147, 152, 155, 504, 505, 506, 701 et seq., and 901 et seq. There are significant legal issues arising under federal and state laws for persons other than issuers who act as agents for issuers in private placements.


Copyright © 2008 Fairfield and Woods, P.C., ALL RIGHTS RESERVEDNational Law Review, Volume , Number 189



About this Author

John Eckstein, Financial attorney, Fairfield Woods

John Eckstein focuses on the general representation of technology-based companies and venture capital funds, investors, investment bankers, financial advisors and financial institutions. He works often with complex legal structures in entity and project financings; however, lately he has often represented private business owners in the exit sale of their companies.

As a securities lawyer active in corporate finance, John has been involved in a range of offerings in the U. S. capital markets, including initial public offerings, other primary and secondary...