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Section 4(a)(2) Exempted Securities

Section 4(a)(2), “Exempted Transaction”

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. Under Section 4(a)(2), the issuance of securities is referred to as a private 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. As such, any of the securities sold are restricted from resale by the purchaser to individuals other than current owners of the business itself.

Section 4(a)(2) allows for an unlimited number of offerees and investors. The exemption allows the Issuer to 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. There is no bright-line test for sophistication and financial ability to bear risk under the statute.

The exemption applies to both offers and actual sales. Given the broad definition of an offer, any solicitation of interest from a potential purchaser may be considered an offer. If the potential investor does not meet the standard of “sophistication”, then 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.

The two important points to remember are the requirement for sophistication, the applicability of the requirements to offers as well as sales, and the restricted status of the security. Also, if the exemption is challenged at any point, the Issuer bears the burden of proving that it has perfected a valid exemption.

Rule 506, discussed in a separate lesson, is a “safe harbor” for the Section 4(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(2). The requirements for exemption under Rule 506 are less stringent than those under Section 4(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 you fail to meet the requirements, you may still attempt to claim the exemption under Section 4(2) or another exemption.

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