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What is a Section 4 Securities Exemption

24. What is a “Section 4” exemption from registration under the ’33 Act?

Section 4 provides for two statutory exemptions from registration of securities by an issuer. The exemptions available under Section 4 of the ’33 Act provide for transactional exemptions for the securities, rather than a blanket exemption for the security itself.

Private Offering Exemption – Section 4(a)(2) – Section 4(a)(2) provides that, “the provisions of section 5 shall not apply to transactions by an issuer not involving any public offering.” The SEC has deemed certain transactions to constitute “private offerings” and fall outside of the scope of a public offering. That is, the securities are not being sold in a public offering and, therefore, are exempt from the registration and reporting requirements of Section 5.

•    Note: Rule 506, discussed in a separate lesson, is a “safe harbor” for the Section 4(a)(2) exemption. That is, if you follow the requirements of Rule 506, but fail to perfect the exemption, you may still qualify for an exemption under Section 4(a)(2). The requirements for exemption under Rule 506 are less stringent than those under Section 4(a)(2). For example, Rule 506 allows for purchase by non-sophisticated investors through an agent (purchaser representative). The main advantage of having this safe harbor provision is that, in the event the issuer fails to meet the requirements, it may still attempt to claim the exemption under Section 4(a)(2) or another exemption.

The characteristics of a section 4(a)(2) offering are as follows:

•    Exempt Transactions – Section 4 provides for a long list of exempt transactions that include:

⁃    transactions falling under Section 4(2) and Reg. D and Rule 144A;

⁃    securities issued as compensation – Rule 701;

⁃    cross-border rights and exchanges for business combinations: Rule 800-802; and

⁃    foreign issuances: Reg. S (Rules 901-905).

•    Benefits of Section 4(a)(2) – Section 4(a)(2) allows for the following benefits:

⁃    there is no geographical limitations on the issuance within the United States,

⁃    an unlimited number of offerees and investors, and

⁃    there is no limit upon the amount of money raised in the issuance.

•    Limitations of Section 4(a)(2) – The following limitations apply to a section 4(a)(2) exemption:

⁃    Disclosure – Prospective purchasers must receive the pre-sale, statutory disclosures in the form of a private placement memorandum.

⁃    Sophistication Requirement – The issuer may offer or sell securities only to investors who are sophisticated and are not in need of the public protections afforded under the SEC’s regulations. Courts have interpreted this standard to mean that an investor must have the financial ability to bear the risk of loss in the investment or extensive business experience and open access to necessary information.

⁃    Note: There is no bright-line test for sophistication and financial ability to bear risk under the statute. If the potential investor does not meet the standard of “sophistication”, the exemption could be lost. If so, any investor who purchased securities within twelve months of the unauthorized offer will have an action to rescind the purchase of the security.

⁃    Integration – This offering may be integrated with prior offerings within the past 12 months.

⁃    General Solicitation – The offering cannot involve the general solicitation of purchasers. This concept is discussed further below.

⁃    Restricted Securities – These are “restricted securities”. They cannot be resold unless:

⁃    they are held for 6 months (reporting company) or 12 months (not a reporting company), or

⁃    they are registered prior to resale, or

⁃    the seller perfects another transactional exemption.

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