Chapter 6

• Jurisdiction: United States

Chapter 6 The Law of Resales: Secondary Market Transactions, Underwriters, Control Persons, and Rules 144 and 144A

As we have seen, the principal purpose of the Securities Act of 1933 was to establish a framework for the offer and sale of securities that was premised on disclosure. Unlike the purchase of a loaf of bread that can largely (although not entirely) be inspected by the buyer before a purchase, the purchase of a security without disclosure about the character of the security and what it represents would largely be a crapshoot. Congress decided that the solution to this problem was the public registration of securities with the SEC with a full disclosure of the relevant facts as a predicate to the offer and sale of securities to the public. But does that always occur?

May a purchaser who bought registered securities from an issuer resell them? Under common law, you might think—correctly—that the answer is clearly yes. But under the 1933 Act, the answer is not so clear.¹ Section 5 makes it unlawful for "any person" to offer or sell a security unless the security is the subject of a registration statement or qualifies for an exemption from the registration requirement. The holder—the person who bought the registered securities from the issuer—cannot take advantage of the issuer's original registration statement; it legitimizes only original sales by the issuer. If the holder wants to sell, the holder must either register the securities itself—an unlikely scenario since the holder would not have the necessary access to the required information for a registration—or qualify for an exemption.

The most likely available exemption is found in Section 4(a)(1) of the Securities Act, pursuant to which all offers and sales of securities are exempt from the registration requirement except those made by an "issuer, underwriter, or dealer." In other words, if the seller is not one of those three, the seller is free to sell the security in question without limitation. Section 4(a)(2) of the Securities Act exempts "transactions by an issuer not involving a public offering." Under this section an issuer may sell a security in a "private placement" without registration under the Act.

Section 2(a)(11) defines an "underwriter" as one who has purchased with a view to "distribution." For the purposes of that statute, a "distribution" is the same as a sale or a public offering. What does it mean for a purchaser to purchase from an issuer "with a view to distribution"? What if the purchaser sold the securities a month after purchasing them? Two months? Three months? There is probably a rebuttable presumption in those cases that the purchaser made the purchase with a "view to distribution." If the resale is deemed to be a "transaction" rather than a "distribution," there is no limitation on the resale.

Does there have to be a connection or relationship between the purchaser and the issuer for the presumption to apply? One of the definitions of "underwriter"—the second definition in Section 2(11)—requires such a relationship, but in SEC v. Chinese Consolidated Benevolent Ass'n, 120 F.2d 738 (2d Cir. 1941), cert. denied, 314 U.S. 618 (1941), the Second Circuit held that a holder could be considered an underwriter even if there were no direct connection between the two.

There is another way out for the holder, however. The holder can prove that at the time of the purchase, the holder had an "investment intent." How to prove that? There are at least two ways: first, prove that the subsequent sale took place after there was a change in the holder's circumstances in a dramatic way,² or second, prove that the securities were held for an appropriate period of time, say, three years.

In reality, the SEC has largely ignored such resales because the strict application of a no-resale rule would significantly impact the post-offering trading of the issuer's securities. The fact that there is a registration statement already on file probably influenced the decision.

But what if the securities being offered and sold were not registered? What if the securities qualified for one of the exemptions to registration (discussed in an earlier) and were sold to the purchaser without a registration statement on file? If the holder of the security wanted to resell it without the registration statement, wouldn't the sale run afoul of the very thing that Congress sought and intended to prevent, a sale with no disclosure? Remember that such securities are called "restricted securities" for a reason.

What are the restrictions on resale of unregistered—restricted—securities? We know that if our holder of restricted securities acquired the securities in order to resell them, there is a problem. Similarly, there is a problem if the holder is selling the securities "for the issuer." However, there are solutions to this conundrum, and we discuss them below.

Under What Circumstances May a Purchaser of "Restricted Securities" or a "Control Person" Who Owns Securities of the Issuer Resell Them?

Let's assume for discussion purposes that the holder who wishes to sell the securities purchased them in a private placement and therefore that they are "restricted securities."³ How can the holder resell those securities? There are actually five ways in which that can be done lawfully:

1. in a registered offering;
2. in a further private placement (this is the Section 4(1)(½)⁴ exemption described in Chapter 5);
3. in a sale to the public in a transaction not involving a "distribution";
4. in a sale to a Qualified Institutional Buyer (QIB) who purchases for its own account (assuming that the securities that are not publicly traded); and
5. in an offshore transaction under Regulation S.

To take advantage of one of those possibilities, our holder would have to take care not to be deemed an underwriter by showing that the holder did not purchase with a view to distribution. Our holder would also need to establish that...