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Spring 2013Securities Regulation

Linda Boss

Module V Notes

March 14, 2013

6. EXEMPT OFFERINGS

Statutes and Regulations Securities Act

o Section 3(a)(11)o Section 3(b)o Section 4(2)o Rule 135co Rule 147o Rule 152o Rule 155

Regulation Ao Rules 251-263

Regulation So Rules 901-905

Regulation Do Rules 501-508

I. Introductiona. Why some companies should be exempt

i. Expenseii. Not all investors require the same level of protection

1. We’re talking about high net worth individuals with money to invest—how much protection do they really need?

b. Lawyers spend a lot of time trying to get their private placements to fit within the private placement exemptions.

c. Only for ‘qualified investors’i. have to be sophisticated plus…

ii. they have to have access to informationd. statutory language

i. 4(1)—transactions by any person other than an issuer, underwriter, or dealer.

ii. 4(2)—transactions by an issuer not involving any public offering

1. ‘transaction’= any type of deal. Look at it in context. Under section 5, transactions are offers, sales,


distributions of prospectuses, distributions of securities,

2. what is a non-public offering?a. Doesn’t require registration b/c we think

investors are not dumbi. Those who can fend for themselves

II. Section 4(2) Offeringsa. Exempts ‘transactions by an issuer not involving any public offering’

from § 5 b. Factors relevant to determining whether an offering is ‘public’

i. The number of offereesii. The relationship of the offerees to each other and to the issuer

iii. The number of units offerediv. The size of the offeringv. The manner of the offering

c. SEC v. Ralston Purina Co. i. Facts

1. Company gave certain employees company stock, about 500

ii. Issue1. Is this a ‘public’ offering?

iii. Reasoning1. ‘blue sky’ laws are clear that to be public, an offer need

not be open to the whole world2. absent a showing of special circumstances, employees

are just as much members of the investing ‘public’ as any of their neighbors in the community

3. keep in mind the broadly remedial purposes of federal securities laws

4. the focus of the inquiry should be on the need of the offerees for the protections afforded by registration.

5. The employees here were not shown to have access to the kind of information which registration would disclose

6. Qualified investors are ‘people who can fend for themselves’

iv. CLASS NOTES1. Supreme court’s first and only attempt defining

nonpublic offering2. Before this case, the idea of private placement was

fewer than 35 investors, involving not a lot of securities, not a lot of $$, all from a 1935 SEC general counsel opinion


3. Purina’s argument is that they’re selling only to special employees and so it’s not a public offering since investors are limited

4. They look at the statutory purpose and come to the conclusion that an offering to those who are shown to be able to fend for themselves is a transaction not involving any public offering

5. They REJECT the idea that quantity limits based on $$, size, # of offerings, etc. = private placement

d. Doran v. Petroleum Management Corp.i. Facts

1. PMC offered 8 investors securities in oil drills2. Doran accepted the offer, only one except MArty

a. Doran is certainly qualifiedb. He has access to information, better than public

investors3. Deal went sour; sued

ii. Procedure1. PMC argued exempt because not a public offering2. Appellate court said private3. Reversed/remanded

iii. Reasoning1. Consideration of the factors for public vs. private are

not exclusive2. Looking at the following factors, ct. finds as follows3. Number of offerees

a. # of offerees, not purchasers, is relevant number. 8 investors were offered and that’s consistent with a finding that the offering was private

4. relationship with issuera. focus on relationship should be on information

available to the offerees by virtue of this relationship

b. if plaintiffs did not possess the information requisite for a registration statement, they could not bring their sophisticated knowledge of business affairs to bear in deciding whether or not to invest

c. there must be sufficient basis of accurate information upon which the sophisticated investor may exercise his skills

d. the requirement that all offerees have available the information registration would provide has been firmly established as a necessary condition of gaining the private offering exemption


5. ‘availability’ of information means either disclosure of or effective access to the relevant information

6. it might be shown the offeree had access to the files and record of the company that contained the relevant information

iv. CLASS NOTES1. Can a qualified investor claim exempt just because

another investor was NOT qualified?2. The defendant has to show that every investor was

qualified3. Issuer also has to show that all of the offerees were

qualified4. Qualified means

a. Sophisticationb. Knowledge and experiencec. Access to all information—any information you

would be getting in a prospectus5. Issuer has the burden of showing that you have an

exempt transaction—even in criminal cases. v. CLASS CHART

1. Issuer-any2. $ limit-none3. no offers to ‘unqualified’ investors4. no limits on # investors5. only qualified investors can purchase6. ‘access’ disclosure (sliding scale)7. resales only to ‘qualified investors’8. no SEC filing until file registration statement.

e. Class Hypotheticalsi. Hypothetical 2

1. Madeline is going to sign a document that makes reps and warranties that she is ‘qualified’

2. Can she sign away her rights? She’s the person we’re trying to protect, why should issuers get around the liability

3. § 14—any condition stipulation or provision binding any person acquiring any security to waive compliance with any provision of this title or of the rules and regulations of the commission shall be void

a. her letter is VOIDii. hypothetical 3

1. mark won state lottery of 20 million2. PML sends mark offering circular that looks like

prospectus3. Mark invests and wants $ back


4. What if Mark hires Warren Buffet to be his personal representative?

a. Warren’s not investing; mark isb. Can you buy experience and sophistication?c. Why not say other rules will protect him?d. The SEC says you can buy sophistication, if you

or your investor rep has the experience and knowledge it’s all good and you’re qualified

iii. Hypothetical 41. Martha manages O&G. venture capital fund. 2. She never receives drilling logs but she requested them3. She wants out b/c no access to information4. She’s not someone who needs protection, but she never

got access to her information5. Is this a sliding scale where super sophistication makes

up for lack of access??6. Maybe. Most people call this a sliding scale. 7. It was her decision to go forward and then use this as an

excuse as an ‘unsophisticated’ investoriv. Hypothetical 5

1. O&G sells investment to mystery investor Marty2. what if Martha sells to an unqualified investor?3. Issuer to qualified to unqualified. What happens?4. if qualified investor resells, it might be deemed

statutory underwriter b/c there was intent to resell and distribute

5. If it sells to unqualified investor, at that point the issuer has engaged in public offering. Every other investor could not rescind b/c of that one unqualified investor.

6. Issuers are very careful to say you can’t resell. v. Hypothetical 6

1. PM wants to sell stock to employees—ESOP2. Any employee can invest3. Is registration required when private company sells to

its own employees?a. For non-public companies, rule 701 exemption

w/ SECb. Says if you’re selling pursuant to written plan

and purchasers are employees, c. And you sell only up to a million, OR 15% of net

assets, or 15% of outstanding sharesd. Then you have to have a plan, some basic

financials, and how the employee pays/withdraws

e. Becomes ‘restricted stock’


4. What if the company goes public?a. You have to use Form S-8b. You have to have a written planc. The purchasers can only be employeesd. No limit on amountse. You have to have plan, and you can refer to the

SEC filingsf. You must describe any restrictions

III. Regulation Da. Rule 506 provides a safe harbor for the § 4(2) exemption

i. Open to all issuersii. Only one that is a § 4(2) exemption

b. Offerings under § 3(b) of Securities Act allows SEC to exempt from § 5 offerings up to $5 million

c. Rule 501 provides definitionsd. Rule 502 sets forth various requirements referenced by 3 types of

offerings found in 504-506e. Rule 505

i. Excludes investment companiesii. Disqualifies certain issuers w/ past securities law violations

f. Rule 504i. Prohibits investment companies, blank check companies, and

Exchange Act Reporting issuersg. Regulation D differ w/ respect to each category that is its own subject

below…h. Aggregate Offering Price

i. Rule 5041. Issuers can sell up to one million in securities

ii. Rule 5051. Up to five million

iii. Rule 5061. Unlimited amount

iv. Constraining this price limits potential scope of offeringv. Aggregation rules

1. Issuers must reduce offering price ceiling by amount of securities sold in twelve months preceding offering pursuant to either—

a. Offering under § 3(b); orb. Offering made in violation of § 5

i. Purchasersi. Regulation D limits # purchasers

ii. Rule 5041. No limit2. One million aggregate indirectly constrains #

purchasers


iii. Rule 505 and Rule 5061. 35 purchasers2. # purchasers excludes from purchasers any ‘relative,

spouse, or relative of the spouse of a purchaser who has the same principal residence as the purchaser’

3. excludes ‘accredited investors’ from purchaser tallya. includes large entities and institutions, including

banks, broker-dealers, and insurance companiesb. trusts, partnerships, corporations also may apply

i. minimum 5 million total assetsc. any director, executive officer, or general partner

of issuer of securities 501(a)(4)d. natural purpose whose individual net worth, or

joint net worth with that person’s spouse, at the time of his purchase exceeds $1,000,000 501(a)(5)

e. natural person whose individual income exceeded $200,000 in each of the two most recent years or whose joint income with his/her spouse exceeded $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year 501(a)(6)

4. Rule 505 still has constrained 5 million aggregate priceiv. Rule 506

1. Must meet sophistication requirement2. 506(b)(2)(ii)—every purchaser who is not an

accredited investor either alone or with his purchaser representative has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risk of the prospective investment, or the issuer reasonably believes immediately prior to making any sale that such purchaser comes within this description.

3. Factors—a. Wealth and incomeb. Experiencec. Educationd. Present investment statuse. Performance on an investment test

v. Securities Act provides for exemption from § 5 for offers and sales to accredited investors under § 4(5) of the Act

1. Limited to $5 million established under § 3(b)2. Issuers or reps cannot engage in ‘advertising or public

solicitation’3. Must file notice of transaction w/ SEC under Form D


4. Rarely used by itselfvi. Issuers rely on placement agents to provide access to pools of

accredited investors1. Rule 501(a) says issuers just has to ‘reasonably’ believe

an investor qualifies as accredited investorvii. Regulation D resales are limited from date of investment

unless securities are registered under § 5 or selling investor finds an exemption from § 5

viii. Regulation D has no inflation adjustmentix. Dodd Frank

1. requires SEC to adjust 1 million net worth test for natural person to become accredited investor to exclude ‘value of primary residence of such national person’

2. SEC must review definition of accredited investor to see if it should be adjusted ‘for the protection of investors, in the public interest, and in light of the economy’

3. SEC must review definition in its entirety every 4 yearsx. Commonly understood definition of net worth is ‘the difference

between the value of a person’s assets and the value of the person’s liabilities’

xi. Primary residence = home where a person lives most of the time.

j. General Solicitationi. Regulation D addresses ‘offerees’ separately from purchasers

ii. 502(c) bans general solicitations1. applies to 505 and 506 offerings2. 504

a. exempts issuers from 502(c) if the issuer meets certain state law offering requirements as outlined in Rule 504(b)(1)(i)-(iii)

b. may avoid solicitation ban if issuer sells exclusively in a state that provides for registration of the securities under state law

c. requires public filing and delivery to investors of a ‘substantive disclosure document’ prior to sale

3. issue—what is a general solicitationiii. In the Matter of Kenman Corp.

1. Factsa. Sold limited partnership interests to 25 investors

who invested $280,000b. No registration statement filedc. Form D was filedd. Securities firm mailed information concerning

the investment to unknown # of persons


i. Chosen from 6 sourcesii. Participants in prior offerings

iii. Fortune 500 company executive officersiv. Previous investors of $10K or more in

real estatev. Physicians in CA

vi. Managerial engineers employed by Hughes Aircraft co. and similar cos.

vii. Morris County, NJ Industrial Director and selected names of presidents of certain companies.

2. Reasoninga. No exemption from registration was availableb. These were ‘offers’ and ‘prospectuses’c. The exemption of 4(2) is not available to an

issuer that is engaged in general solicitation or general advertising

d. Since this was a general advertising, the safe harbor of Rule 506 and the 4(2) exemption were not available.

iv. SEC No-Action Letter Mineral Lands Research & Marketing Corporation

1. The SEC will not issue no-action letters with respect to transactions under Regulation D

2. Proposal to offer to 600 people who are existing clients of an officer who is an insurance broker

a. The types of relationships with the offerees that are important in establishing no general solicitation are those that will enable the issuer to be aware of the financial circumstances or sophistication of the persons with whom the relationship exists or that otherwise are of some substance and duration

v. Brokerage firms may actively solicit investors with a general interest in investing in private placements

1. Solicitation cannot mention particular private placement offering

2. Brokerage firms must have time to assess sophistication of investors

k. Disclosurei. Regulation D private placements don’t completely eliminate

disclosuresii. Rule 502(b)

1. Divides Regulation D intoa. Type of investor


b. Type of offering2. Rule 504/non-accredited and accredited investor

a. No specific disclosure required3. Rule 505/506/accredited investor

a. No specific disclosure required4. Rule 505/506/non-accredited investor

a. Specific disclosure required by Rule 502(b)(2)b. Disclosure based on type of issuer and size of

offeringi. Up to 2 million/non-exchange act

reporting company1. Non-financial info under 502(b)(2)

(i)(A)2. Financial info under 502(b)(2)(i)

(B)(1)3. Article 8 of Regulation S-X

ii. Up to 7.5 million/non-exchange act reporting company

1. Financial info under 502(b)(2)(i)(A)

2. Non-financial info under 502(b)(2)(i)(B)(2)

3. Financial statement info contained S-1 for small reporting companies

iii. Over 7.5 million/non-exchange act reporting company

1. Non-financial info under 502(b)(2)(i)(A)

2. Financial info under 501(b)(2)(i)(B)(3)

3. Financial statement info contained in public offering registration statement

iv. Offerings of any size/exchange act reporting company

1. 502(b)(2)(ii)2. either provide combo of recent

annual report, proxy statement, and 10-K; or

3. 10-Kif contains info found in annual report

c. must provide ‘brief description of the securities being offered, the use of proceeds from offering, and any material changes in the issuer’s affairs


that are not disclosed in the documents furnished’

d. issuer must give purchaser ‘opportunity to ask questions and receive answers’ relating to the offering

e. issuer must supply any additional information necessary to verify accuracy of specific mandatory disclosure items upon request of any purchaser provided issuer ‘possesses or can acquire without unreasonable effort or expense’ the information

l. Resale Restrictionsi. Generally cannot be freely resold w/ one exception

1. Rule 504 offering that complies w/ state law registration requirement can freely resell securities

2. Small size of Rule 504 and state law restrictions limit secondary market

ii. 505/506, 502(d) restricts resales1. issuer must take reasonable care to discourage

investors from reselling securitiesiii. restrictions on resale severely impinge the ability of investors

to realize their capital appreciation—no opportunity to diversify portfolio

iv. private placement investors typically requires an illiquidity discount to induce them to purchase

m. Integrationi. Integration doctrine restrains ability of issuers to

recharacterize offerings strategicallyii. Factors relevant in determining whether to integrate

transactions1. Whether sales are part of single plan of financing2. Whether sales involve issuance of same class of

securities3. Whether sales have been made at or about the same

time4. Whether the same type of consideration is received5. Whether sales are made for the same general purpose

iii. SEC provides safe harbor under 502(a)1. Applies six months prior to start of offering and six

months after end of offering2. Two time periods

a. Safe harbor windowi. Beginning of pre-offering six month

period to end of post-offering six month period


b. Six-month periods windowi. Pre-offering and post-offering six month

periods but not time period of offering itself

3. Sales outside safe harbor window are separate from Regulation D offering, with one exception

a. During six month periods window, if issuer offers or sells securities that ‘are of the same or similar class as those offered or sold under Regulation D’ then issuer loses safe harbor entirely

n. Innocent and Insignificant Mistakesi. 508

1. failure to comply w/ requirement for 504, 505, 506 offering don’t necessarily result in loss of exemptions for an offer or sale to a particular individual or entity

ii. why allow mistakes?1. Investors in regulation D offering are more

sophisticated compared with investors in public offering

2. Limited in several respectsa. Does not shield issuer from SEC enforcement

actionsb. Rule 508 limits excuse to those situations where

‘failure to comply did not pertain to a term, condition or requirement directly intended to protect that particular individual or entity’

c. Eve if failure to comply was not related to a requirement directly intended to protect the particular investor suing, Rule 508 will also be unavailable to the issuer unless the failure to comply was ‘insignificant with respect to the offering as a whole’

d. ‘significant’ failures are—i. general solicitation prohibition

ii. aggregate offering price limitationiii. limit on # purchasers

3. requires ‘good faith and reasonable attempt was made to comply with all applicable terms, conditions, and requirements of 504, 505, 506’

o. Disqualificationi. Rule 504

1. No disqualification provisionii. Rule 505

1. Disqualification in certain circumstances


2. References only disqualifiers in Regulation Aiii. Rule 506

1. Dodd-Frank requires disqualifiers ‘substantially similar’ to Regulation A

iv. Regulation A Rule 2621. Bad acts of issuer, including predecessors or affiliated

a. Subject of SEC proceeding or examination, or subject of stop refusal in last 5 years

b. Convicted within 5 years prior to first sale of securities under Rule 505 of any felony or misdemeanor w/ securities or ‘false filing’ with SEC

c. Issuer subject to ‘order, judgment, or decree of any court of competent jurisdiction’ in last 5 years that restrains issuer from securities actions

2. Bad acts of key individuals and entities connected w/ issuer or offering, including director or officer of issuer, beneficial owner of 10% more of class of its equity securities, and any promoter of the issuer presently connected with it in any capacity, and any person paid for solicitation of purchasers in connection w/ Rule 505 offering, as well as partner, director, or officer of soliciting agent

a. Conviction for felony or misdemeanor related to purchase or sale of securities in ten years prior

b. Court order, judgment, decree in last 5 years related to securities

3. Bad acts of soliciting agentsa. Acted as underwriter and underwrote in

securities offering under proceeding or examination, stop order, etc.

4. Any person subject to final order from one of following—

a. State securities commissionb. State authority that supervises banks, savings

associations, credit unionsc. State insurance commissiond. Federal banking agencye. National credit union administrationf. Order must bar them from their activities or

violation of law or regulation of or conductv. Rule 507 is general disqualification, but is narrow, focusing on

issuers in past that have failed to comply w/ notice filing requirement of 503.


vi. SEC can waive disqualification if Commission determines, on good cause, not necessary

p. Other Aspects of Regulation Di. State Securities Regulation

1. ‘blue sky’ regulations2. most states combine disclosure w/ limited merit review3. ‘uniform’ act allows states to pick and choose among

antifraud liability, disclosure, and merit regulation options

4. NSMIA exempts certain securities from state securities registration requirements, those covered as exempt offerings under Rule 506

5. Doesn’t include Rules 504 or 505 securities6. Most states have adopted exemptions from registration

ii. Rule 5041. Allows issuers to avoid general solicitation, disclosure,

resale restriction requirements2. Must meet state law requirements

a. Issuer may sell securities in states that provide for state registration of securities and ‘public filing and delivery to investors of a substantive disclosure document before sale’

b. Issuers may sell in states that have no state registration requirement, so long as they comply with registration and public filing and delivery requirements of another state

c. Issuers may make sales ‘exclusively according to state law exemptions from registration that permit general solicitation and general advertising so long as sales are made only to ‘accredited investors’ as defined in 501(a)

iii. Form D1. 503 requires 504, 505, 506 requires Form D filing2. has until 15th day after start of offering3. contains basic info on issuer and offering, including

promoters of offering, 10% beneficial owners, executive officers and directors, broker-dealers, minimum investment required, offering price, # investors, expenses, and use of proceeds

iv. Exchange Act Filing1. Must file Form 8-K2. Info in Item 701 of Regulation S-K3. Must provide info on Form 10-K and 10-Q filings

q. The Private Placement Processi. Hire placement agent to assist in offering


1. Best efforts offeringsii. Agent reviews business/finances of issuer

1. ‘due diligence’ package to give investorsiii. agent will write up private placement memorandum

1. similar info to public offering statutory prospectusiv. agent will market offering

1. contact investors with whom agent has pre-existing relationship

2. roadshow meetingsv. investors negotiate w/ issuer

vi. investors purchase1. agent assists w/ subscription agreements and transfer

of money and securitiesr. CLASS CHART

i. Section 4(2) Rule 5061. Issuer—any2. $ limit—none3. marketing—varies4. # investors—35 non-accredited5. type—acredited/nonaccredited6. disclosure—only to non-accredited7. resales—‘restricted’8. SEC filing—yes9. Most people use this exemption, even those who just do

really small sales. ii. 3(b) Rule 504 safe harbor

1. issuer-no 34 act, blank check, ‘inv cos?’2. $ limit-1 million (12 mos.)3. marketing—no general solicitations4. #/type investors-no limits5. no disclosure6. ‘restricted’ resales7. SEC filing-yes

iii. 3(b) Rule 505 safe harbor1. no inv cos—no ‘bad boys’2. $ limit- 5 million (12 mos.)3. no general solicitations4. # investors—35 non-accredited5. type—accredited/non-accredited6. disclosure only to non-accredited7. ‘restricted’ resales8. SEC filing-yes

IV. Why would other exemptions be necessary?a. Needs of small business issuersb. Presence of alternative regulatory regime


c. Importance of national boundaries and need to respect the authority of other countries

V. Regulation Aa. Provides exemption from § 5 for offerings of up to 5 millionb. Rules 251-263 of Securities Actc. Establishes procedure for ‘mini public offering’d. Allows certain non-exchange act reporting issuers to raise more

capital than 504 w/ fewer gun-jumping restrictions than public offerings

e. Has disqualifying provisionf. Mandatory disclosure requirements on issuers

i. Offering statementii. Offering circular

iii. No need to audit financial statementsg. Immediate secondary market tradingh. Must comply w/ ‘blue-sky’ securities lawsi. CLASS CHART

i. Issuer—no ’34 act—‘bad boys’ excludedii. $ limit--$50 million (12 mos.)

iii. marketing—you can test the watersiv. # investors—no limitsv. type of investor—no limit

vi. disclosure—offer circular, unaudited.vii. Resales—none

viii. SEC filing—yes. j. Practically, no one uses this exemption, because you still have to

register under state law. Why go through federal exemption process when you still have to go through state exemption. If doing it in more than one state, you also have to get reciprocity.

k. Test the Watersi. Gun-jumping rules mirror public, focusing on 2 events

1. Filing of offering statement w/ SEC2. Qualification of offering statement, when sales can

commenceii. Issuers can ‘test the waters’ in pre-filing period

1. Issuers can provide writings to prospective purchasers2. Strictly limited to pre-filing period3. Must wait 20 days for sales after test waters

communicationiii. Can be integrated w/ later public offering, resulting in gun-

jumping violationsiv. Integration safe-harbor under Rule 254

1. 30 calendar days elapsed between last solicitation of interest and filing of registration statement with SEC


l. Internet Offeringsi. Internet offerings through Regulation A happen, but aren’t real

popular after collapse of internet bubble. VI. Intrastate Offerings

a. Why exempt them?i. Smaller in scope and are sold to investors that have a general

knowledge of the typically local companies offering the securities, reducing the need for broad-based securities protections of § 5

ii. Less effect on confidence of investors in national securities marketplace

iii. State ‘blue sky’ securities regulation provides a substitute. iv. State regulators have greater incentive and greater ability to

police the offeringv. Dormant commerce clause—if it affects intrastate commerce,

state is incapable of regulation. If it is entirely intrastate, then the state can regulate and should regulate. Here, this is the philosophy with intrastate offerings and Rule 147.

b. Who uses this exemption?i. Issuers raising money only from local sources

ii. Those wanting to save moneyc. National Securities Market Improvement Act of 1996 preempts state

securities registration requirement for ‘covered securities’i. Does not include securities offered and sold under § 3(a)(11)

d. Section 3(a)(11) Offeringsi. Statute (should be read as a transaction exemption)—

1. Any security which is a part of an issue (red flag—integration) offered and sold only to persons resident within a single State or Territory, where the issuer of such security is a person resident and doing business within or, if a corporation, incorporated by and doing business within, such State or Territory.

a. LLCs, partnerships, etc. are ‘persons’ doing business

2. SEC construes this narrowly. ii. This exemption should be plan B—you shouldn’t rely on it. It

should be relied on if you screw up and another exemption didn’t work out for you. Always use another exemption first. This one is too risky.

iii. Securities Act Release No. 44341. ‘issue’ concept

a. an offer to a on-resident not allowedb. may likely be considered an integrated part of an

offering previously made or proposed to be


made, so if those include non-residents, be careful.

c. Even secondary market can only be residentsi. Obtain assurances

2. Doing business within the statea. Must have substantial business operational

activities in the state of incorporationb. If proceeds are used to conduct business outside

of state, no exemptionc. Don’t create a new entity—it will be considered

one. 3. Residence within the state

a. Presence in the state isn’t enough to be a resident

i. Includes militaryb. Formal reps of residency isn’t enough—you

should rely on morec. If the offering is too large—we’ll presume it’s

doubtful intrastate4. Resales

a. Sale to one non-resident destroys exemption for all residents

b. If they come to rest, and then are re-sold, might not defeat exemption

c. The non-residence of an underwriter or dealer isn’t pertinent as long as ultimate distribution is solely to residents of that state

iv. Busch v. Carpenter1. Facts

a. Sonic was UT corporation, sold securities to UT residents, then was contacted about a merger w/ a company in IL

b. Money from securities sale was never used in UTc. Plaintiffs are CA residents and bought stock

through brokerage account in UT2. Procedure

a. DC said resale of stock to nonresidents occurred after securities came to rest in UT

3. Reasoninga. ‘coming to rest’

i. SEC says b/c defendants have burden to show right to exemption, they have burden of showing original buyers bought w/ investment intent


ii. Rejects SEC. a seller seeking SJ makes prima facie showing that offering was consummated within state by showing stock was sold only to residents of that state. Issuer not required to disprove all possible circumstances that might establish the stock hasn’t come to rest.

iii. Purchaser has burden of producing contrary evidence on this issue when seller has satisfied facial requirement of statute

4. ‘doing business’a. doing business refers to activity that actually

generates revenue within an issuer’s home stateb. more substantial activity than that which would

exercise personal jurisdictionc. fact issue still exists regarding Sonic’s use of the

proceeds, since corporation never did more than maintain an office in UT

v. when are sales to investors outside the states integrated?1. Same general purpose2. Same plan of financing3. Same consideration4. Close in time to one another5. No view on how to balance these factors if they go

different waysvi. When do sales to investors within the state ‘come to rest’

1. Depends on ‘investment intent’2. Shouldn’t rely upon passage of time

vii. CLASS CHART1. Issuer—resident/incorporated ‘within’ state2. $ limits-none3. marketing—only offer to ‘in state residents’4. # investors no limits5. only sell to ‘in state residents’6. no disclosure requirement, subject to state bleu sky

laws7. only ‘in state’ resales until the securities come to rest8. no SEC filing, until the registration statement.

a. Part II of the registration statement requires you to come clean and expose all past relationships, describing them in detail.

e. Rule 147i. Safe harbor statute


1. Those who fail to meet these requirements may still be exempted

ii. CLASS CHART1. Issuer—organization or principal office, using the 80%

test2. $ limits—none3. marketing—‘principal office/residence’4. # investors—none5. type of investors—‘principal office/residence’6. no disclosure, subject to state blue sky laws7. resales—9 month safe harbor restriction8. no SEC filing until you file the registration statement.

iii. How is Rule 147 different from 3(a)(11)?1. It gives you some definitions and objective standards

for issuer, marketing, and type of investor. 2. Gives you an objective standard for when securities

‘come to rest’3. Bright-line test

iv. Exchange Act Release No. 54501. Transaction concept

a. Exemption covers only specific transactions and not securities themselves

2. ‘part of an issue’a. certain offers and sales of securities will be

deemed not to be part of an issue and therefore not be integrated

b. no definition of ‘part of an issue’i. apply five factor integration test

3. ‘person resident within’a. interpreted narrowlyb. provides objective standards for when a person

is considered a resident within a state for purposes of the rule and when securities have come to rest within a state

4. ‘doing business within’a. strict complianceb. business should be located within the state, and

principal or predominant business must be carried on there

c. substantially all of the proceeds of the offering must be put to use within the local area

d. provides specific % amounts of business that must be conducted withint eh state, and of proceeds from the offering that must be spent in connection with such business


5. Synopsis of Rule 147a. Preliminary notes

i. Safe harborii. Only for issuer—not secondary market

b. Transactions covered 147(a)i. Issuer must be resident and doing

business w/in state or territoryii. Offerees and purchasers must be resident

iii. Resales for period of 9 months after the last sale which is part of an issue must be limited as provided—this gets rid of the prohibition on selling to out of state investors.

iv. Certain offers and sales of securities by or for the issuers will be deemed not ‘part of an issue’ for purpose of this rule only.

c. ‘part of an issue’ 147(b)i. all securities sold prior to 6 months

before or after the sale are deemed not part of an issue—this gets rid of the issue of integration.

d. ‘nature of the issuer’ 147(c)—‘person resident within’ 147(c)(1)

i. corporation, limited partnership or business must be incorporated or organized pursuant to the laws of such state or territory

e. ‘nature of the issuer’ 147(c)—‘doing business within’ 147(c)(2)

i. 80% of gross revenues and subsidiaries on consolidated basis for--most recent fiscal year; or 6 month period after, or 12 months before that period, were derived from operation of a business or property located in or rendering of services within the state

ii. 80% of issuer’s assets and subsidiaries at end of most recent fiscal semi-annual period prior to the first offer of any part of the issue are located within such state

iii. at least 80% of net proceeds to issuer from sales made pursuant to the rules are intended to be and are used in connection with the operation of a business or


property or the rendering of services within such state or territory; and

iv. issuer’s principal office is located in the state

f. offerees and purchasers—‘persons resident’ 147(d)

i. principal residence in stateii. if purchasing on behalf, that person must

be residentg. limitations on resales 147(e)

i. during period securities are offered/sold, and 9 months after last sale, resales can only be made to residents

h. precautions against interstate offers and sales 147(f)

i. requires issuers to take steps to preserve the exemption provided by the rule

ii. if issuer--1. place a legend on certificate stating

securities aren’t registered under act and set forth limitations on resale

2. issue stop transfer instructions to issuer’s transfer agent

3. obtain written representation from each purchaser as to his residence

iii. if issuer selling to non-issuer to resale within 9 months

1. do steps 1 and 2 above2. issuer must disclose in writing the

limitations on resalei. operation of rule 147

i. not an exemption from civil liability provisions of 12(a)(2) or anti-fraud provisions of Section 17 of the Act or 12b-5 of Securities Exchange Act

ii. available only for transactions by issuers, not secondary offerings.

f. CLASS HYPOTHETICALSi. Hypo #1

1. Does the 40% out of state customers/supplies affect the exemption? Are they doing business within the state? Are you within the Rule 147 safe harbor?


a. Does this satisfy 80% test? An order is a really valuable asset, and that came from out of state. But the operations are all located in-state, that’s where the order could originate. The ‘order’ is what makes this operation work—that’s the origination of the assets of the corporation. And they’re all out of state.

b. Are these orders subject to state regulation? The activities that produce the orders are subject to those state regulations. That’s why we’re okay with this amount of business being ‘within the state’

c. The notion is that it’s ‘in state’ if the state regulator could regulate fully the business and its operations and anything related to this offering, so that there’s no reason to even have additional federal regulation or enforcement, because the in state regulator could do a complete job.

d. That chosen action, that order, asset, ability to sue a customer and say you have to pay, is something that could be managed in-state. Do things change if this company were buying land in other states?

i. Pennoyer says when it’s land, a state has complete jurisdiction over land. If this involved land, your exemption is probably gone. NC securities commission can’t regulate that land in that other state.

e. The argument is that the 60/40 ratio shouldn’t even matter, because all of the orders are originating and coming from inside NC.

2. What about proceeds being used to buy new warehouse in SC and order center in High Point?

a. By building a new warehouse in SC with the proceeds, you should be concerned.

b. For exemption, use of proceeds must meet the 80% test and use of proceeds is part of the word ‘within’

c. If 85% go to the call center, and 15% go to the warehouse, you’re probably good. If the real estate outside the state is a de minimis problem, they’re not going to deny you the exemption.

ii. Hypo #21. First issue bullet


a. This is an outside investor—not within intrastate offering exemption

b. It’s a VC firm, though—so I’m sure Reg. D or 4(2) would work. Why wouldn’t they?

c. Is this private placement? Is that private placement part of this intrastate offering? This is an integration issue.

d. You should use the 9 month safe harbor. 2. Second issue bullet

a. Can insiders use the intrastate offering exemption?

b. The SEC has said that you can’t use the safe harbor if you’re an insider, but the courts and SEC have accepted that you can use it as an insider, you’re going to be treated as an intrastate issuer. No safe harbor assurances, but it’s still a possibility.

c. Is edgar a ‘control person’? yes. He’s the CEO. iii. Hypo #3

1. First bullet issuea. Can it use intrastate if incorporated in Delaware

w/ headquarters in Atlanta? b. We might need more facts. What if they had a NC

office and only registered reps from NC are working on this deal, and all records of this deal are maintained in NC, and only sold to NC residents, and NC securities commission can regulate this fully. In those circumstances, it might be okay.

c. If it’s a corporation, it does have to be incorporated in the state—that’s for the issuer, not the underwriter as in this case.

d. The underwriter is an ‘investor’ in this case; that’s why this applies.

2. Second bullet issuea. If they do all follow up phone calls in NC, as long

as securities go to NC residents, we’re good. iv. Hypo #4

1. Offering circular to various investors. Any issues?2. Resident in SC—lost exemption. She’s not a NC resident.

a. SEC says address & driver’s license is enough for residency—safe harbor

3. Notarized promise—not enough. She still resides in VA.


a. If you could get out of state investors this way, this would be a waiver of the provisions of the Act and void under the statute.

4. 6 months vacation home in SC—mailing address in NC—

a. his intent is to stay in NC—hilton head is just a vacation place, not a primary residence.

5. Customers fill out form stating NC residences and attach photocopy of NC driver’s license

a. The statute is a strict rule, but the safe harbor in effect allows that if the person is a resident, it’s good but there’s no reasonable belief provision. So you might want to check up.

v. Hypo #51. In oct. carl buys shares, in april his daughter gets into

private law school and he has to sell his sharesa. There are no resales allowed generallyb. You can resale if the securities have come to rest

in-state—after that you’re not part of the issue. You’re trading on a secondary market. How long do you have wait?

i. We don’t know according to the statuteii. But the Rule 147 says 9 months.

iii. Before selling to the in-state resident, make it clear there is no resale.

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