3.3 Offers and Sales of Unregistered Securities

• Library: Corporations and Partnerships in Virginia (Virginia CLE) (2016 Ed.)

3.3 OFFERS AND SALES OF UNREGISTERED SECURITIES

3.301 In General. The Securities Act provides several exemptions from the requirement for the registration of securities for offer or sale to the public. In general, the exemptions are technical in nature, and the burden of proving their applicability rests with the claimant.

3.302 Intrastate Offerings.

A. Statutory Exemption. Section 3(a)(11) provides an exemption from registration for securities offered and sold solely to residents of the state or territory where the issuer resides and conducts substantial opera-tions. ⁵¹ The intrastate exemption, designed to benefit local financing by local industries, is a technical exemption and may inadvertently be lost where care is not exercised in complying with its requirements. For example, a single sale or offer to sell to a nonresident, including relatives and friends of persons controlling the issuer, will destroy the exemption. ⁵²

All offerees and purchasers must be residents of a single state, and according to Securities Act Release No. 33-4434, ⁵³ residency means domicile. Once an offer is made to a nonresident, the exemption is irretrievably lost. The issuer cannot regain it by attempting to rescind the offer or by discontinuing the nonresident sales. ⁵⁴ The exemption will be lost by a sale to transients such as military personnel temporarily stationed within the state. ⁵⁵

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The securities must "come to rest" with a resident who purchases the securities without a view to distribution to a nonresident. As a result, the length of time that the securities are held is critical. ⁵⁶

The issuer must also be a resident of, and doing business in, the same state as the offerees and purchasers. Merely conducting such activities as bookkeeping, maintaining stock transfer records, or similar activities in a given state will not satisfy this requirement. ⁵⁷ Furthermore, even though the issuer conducts substantial business within the state, the exemption will not be available if the proceeds obtained from the offering are to be used to acquire property or to conduct operations outside the state. ⁵⁸ A newly formed company may not claim the exemption while planning covertly to invest the proceeds in another state. ⁵⁹

B. Rule 147. In an attempt to provide greater certainty in this area, the SEC promulgated Rule 147 ⁶⁰ under the Securities Act. Only full compliance with this Rule will ensure that the offering will be exempt under section 3(a)(11). All shares offered or sold as a part of a single issue must meet the Rule's requirement. Rule 147 provides that any offering that is exempted by section 3 or section 4(a)(2) or registered under the Securities Act and that takes place six months before or after offers or sales made pursuant to the Rule is deemed to be a separate and distinct issue. Offerings during this 12-month period are evaluated by many factors to determine whether they are part of the same issue. ⁶¹

To qualify for an offering under Rule 147, the issuer must:

1.	Be a resident of the state or territory in which the offers and sales are made;
2.	Derive 80 percent of its consolidated gross revenues in that state or territory;

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3.	Have 80 percent of its consolidated assets in that state or territory;
4.	Intend to use 80 percent of the net proceeds of the sales within that state or territory pursuant to the Rule;
5.	Maintain its principal office in that state or territory; 62 and
6.	Furthermore, all offerees must be residents of that state or territory. 63

The residence of individual offerees and purchasers will be their "principal residence" at the time of the offer and sale; there need be no subjective intent to remain in the state following the sale. ⁶⁴ The residence of corporations, partnerships, trusts, or other forms of business entities will be the state in which they have their "principal office." ⁶⁵ However, where the entity has been formed for the specific purpose of acquiring the securities, the residency of the owners of the beneficial interest will determine the residency of the entity.

The securities offered pursuant to Rule 147 will be deemed to "come to rest" if, during the offering and for nine months from the date of the last sale that is a part of the offering, the securities are resold only to residents. ⁶⁶

The issuer must take precautions to limit resales to nonresidents during the nine-month "coming to rest" period by placing a legend on certificates evidencing the exemption and establishing stop transfer procedures. ⁶⁷

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3.303 Transactions Not Involving Any Public Offering. Section 4(a)(2) of the Securities Act provides an exemption from registration for issuer transactions not involving any public offering, ⁶⁸ but the Act does not define "public offering." This exemption, like all other exemptions from registration under the Securities Act, is highly technical, and the issuer has the burden of showing that all offerees had a sophisticated understanding of, or access to, the information that a registration statement would otherwise provide. ⁶⁹

To claim an exemption based on section 4(a)(2), an issuer must satisfy a number of factors considered by courts and the SEC. These factors include (i) the number of offerees and their relationship to each other and the issuer; (ii) the number of units offered; (iii) the size of the offering; and (iv) the manner of the offering.

The first of these factors, relating to the number of offerees, generally has been regarded as the most important, since the exemption presumes that the offerees are members of a class either having special knowledge of the issuer or having sufficient financial sophistication to evaluate an investment in the issuer. This is to ensure that offerees are adequately informed before making their investment decision by either having access to all relevant information or the financial sophistication to ask questions to obtain that information. The access requirement is not satisfied by the mere representation by the issuer that all information that an investor desired would be supplied. ⁷⁰ Issuers have the burden of proving that all offerees (not just purchasers) have access to or have received information equivalent to what a registration statement would reveal. ⁷¹ An offering to employees generally or to all existing security holders would not necessarily be exempt under section 4(a)(2). ⁷²

Another important factor to consider in determining the availability of the section 4(a)(2) exemption is whether the securities offered will come to rest in the hands of the initial informed group or whether the purchasers will merely be conduits for a wider distribution. Thus, it is necessary that each

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purchaser acquire the securities for investment for the purchaser's own account and not with a view to distribution to others. To satisfy this condition, it is customary for issuers to require each purchaser to sign an "investment letter" attesting to the person's knowledge of the issuer and its business, the intent to acquire the securities for investment only rather than for distribution, and the person's agreement not to dispose of the securities without providing the issuer with satisfactory evidence that the disposition would not violate the requirements of the Securities Act. Additionally, certificates representing the securities customarily carry legends setting forth the transfer restrictions. Investment letters are not conclusive of the actual intent of the purchasers, and therefore, a misrepresentation by a purchaser could cause the entire private placement exemption to be lost. ⁷³

3.304 Section 4(a)(5). Section 4(a)(5) of the Securities Act ⁷⁴ exempts transactions involving offers or sales by an issuer not in excess of $5,000,000, provided that (i) the securities are sold only to "accredited investors" and (ii) there is no "advertising or public solicitation" with respect to the offering. "Accredited investor" is defined in section 2(15) of the Securities Act ⁷⁵ and Rule 215 thereunder. ⁷⁶

3.305 Section 4(a)(6) and Crowdfunding. The Jumpstart Our Business Startups Act (JOBS Act) ⁷⁷ added section 4(a)(6) to the Securities Act, providing an exemption for certain crowdfunding transactions that otherwise would have to be registered to be lawful. ⁷⁸ "Crowdfunding" refers to the process by which an entity raises capital via the Internet through small, limited contributions from a large number of individuals. Pursuant to section 4(a)(6) of the Securities Act, the SEC has adopted Regulation Crowdfunding effective May 16, 2016. ⁷⁹

The section 4(a)(6) exemption applies to crowdfunded offerings in which (i) the aggregate amounts raised during a 12-month period do not exceed $1,000,000; (ii) the aggregate amount sold to any individual investor

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does not exceed—during the 12-month period preceding the transaction—the greater of (a) $2,000 or 5 percent of the annual income or net worth of the investor when that investor's net worth or annual income is less than $100,000 or (b) 10 percent of the annual income or net worth of that individual investor when the investor's net worth or annual income is equal to or greater than $100,000; (iii) the transaction is conducted through a broker or a funding portal that complies with the requirements of section 4A(a) of the Securities Act; and (iv) the issuer complies with the disclosures required by section 4A(b) of the Securities Act. ⁸⁰

Apart from the above limitations on the individual investor's investment, there is no other requirement that the investor in a crowdfunded offering be accredited or sophisticated, which is a distinction unique to section 4(a)(6) compared to other private placement exemptions. ⁸¹ The JOBS Act and Regulation Crowdfunding preempt state laws designed to regulate crowd-funding. ⁸²

A. Regulation Crowdfunding. Regulation Crowdfunding includes the same investment...