Public offerings, private placements and the prospectus

Register and disclose, or qualify and restrict

The Securities Act of 1933 starts from one position, and section 5 states it as three prohibitions. It is unlawful to sell a security unless a registration statement is in effect; it is unlawful to offer to sell or to offer to buy unless a registration statement has been filed; and a prospectus transmitted for a security under a filed registration statement must meet the statutory requirements. Read together, those three fix the shape of an offering: no offers before filing, subject to limited exceptions, offers but no sales during the cooling-off period, sales once the registration is effective — unless the offering fits an exemption. Registration means filing a registration statement, waiting through a cooling-off period while the staff reviews the filing, and delivering a prospectus to every buyer. The prospectus is the disclosure document drawn out of that filing. By statute a registration statement becomes effective on the twentieth day after filing, or sooner if the SEC sets an earlier date, and an amendment filed before then can restart the count. During the cooling-off period the issuer may use a preliminary prospectus, nicknamed the red herring. Its cover must say the information is not complete and may change, and that the securities may not be sold until the registration is effective. A firm may collect indications of interest, but no offer to buy can be accepted and no money taken until the registration is effective, and an indication can be withdrawn with no obligation.

What the SEC actually does with a filing is the most misread part of the topic. Its Division of Corporation Finance reviews filings selectively, to check compliance with the disclosure and accounting rules, and that review is not a guarantee that the disclosure is complete and accurate; that responsibility stays with the company. A registration statement that is filed or in effect is not a finding by the SEC that it is true, and it never means the SEC has passed on the merits of the security or approved it. Telling a buyer that an offering is approved by the SEC is itself a violation.

The alternative is an exemption. Regulation D lets an issuer sell without registering, chiefly to accredited investors plus a limited number of others, using a private placement memorandum instead of a prospectus. The trade is fewer buyers and much less liquidity in exchange for lower cost and no registration statement. The exemption is from registration only: the antifraud provisions apply to a private placement exactly as they apply to a public one.

Because those securities were never registered, what the buyer holds is restricted. Restricted securities cannot simply be sold on into the market. Rule 144 sets the conditions for resale — a holding period, adequate current public information about the issuer, and for affiliates a volume limit and a notice filing. The same restriction attaches to unregistered shares an employee receives as pay.

Rule 144’s numbers are specific enough to be asked directly. The holding period is six months where the issuer is subject to the reporting requirements and one year where it is not, running from the later of the acquisition from the issuer or from an affiliate. For a non-affiliate selling restricted securities of a reporting issuer, current public information about the issuer must be available until one year has passed since acquisition; after that the condition falls away. An affiliate selling must also satisfy current public information — for a reporting issuer, that it has filed all required reports under section 13 or 15(d) during the preceding twelve months — and a volume cap: in any three months, no more than the greater of one percent of the class outstanding or the average weekly reported trading volume over the four calendar weeks before the notice is filed. Notice on Form 144 is required once the sale in any three-month period exceeds 5,000 shares or an aggregate price above $50,000.

Accredited investor has a definition rather than a feeling, and for a natural person it has two money limbs. Net worth: individual, or joint with a spouse or spousal equivalent, above $1,000,000, excluding the value of the primary residence — and indebtedness secured by that residence, up to its fair market value, is not counted as a liability either. Income: above $200,000 individually, or $300,000 jointly, in each of the two most recent years, with a reasonable expectation of the same in the current year. Either limb is enough. A third route needs no money test: a person who holds a Series 7, Series 65 or Series 82 license in good standing is an accredited investor. The SEC can designate other credentials by order. The exclusion of the home is what turns most exam questions on this, because a candidate who counts it will clear the threshold and give the wrong answer.

Regulation D has two doors and they differ on solicitation. Under Rule 506(b) an issuer may sell to an unlimited number of accredited investors and to no more than 35 non-accredited purchasers in any ninety-day period, and each of those non-accredited purchasers must have such knowledge and experience in financial and business matters that they can evaluate the merits and risks of the investment. Under Rule 506(c) the issuer may advertise, but every purchaser must be accredited and the issuer must take reasonable steps to verify that they are — a review of tax forms, documentation of net worth, a confirmation from a registered professional, or a written representation from an investor verified within the previous five years. Advertising and non-accredited buyers do not go together. Where a Rule 506(b) issuer sells to a purchaser who is not accredited, it must furnish that purchaser specified information a reasonable time before the sale; it need not furnish that information to accredited investors.

A registration does not have to be used all at once. Rule 415 lets an issuer register securities for an offering to be made on a continuous or delayed basis in the future, provided the rule’s conditions are met. This is called a shelf registration: the securities are registered once and then taken off the shelf and sold in tranches as the issuer needs the money. Nothing is exempted. Every sale off the shelf is a sale of registered securities, and a shelf is not a private placement just because the sales come later.

Federal and state filing are two separate questions. The SEC administers the federal answer; each state administers its own securities law, called a blue-sky law. Section 18 of the Securities Act removes state registration for covered securities. Two of these matter at SIE depth: a security listed on a national securities exchange, and a security sold under Rule 506 of Regulation D. For a Rule 506 offering the issuer files a Form D notice with the SEC, and a state may still require a notice filing and a fee, but it may not require the offering to be registered with the state. A state also keeps its authority to investigate and act against fraud and deceit. An offering that is not a covered security, such as an offering sold only to residents of one state, is not relieved of that state’s registration requirements.

Municipal new issues use their own disclosure document. A security issued by a state or a political subdivision of a state is exempt from Securities Act registration, so there is no SEC registration statement or prospectus. The official statement is the document prepared by or for the municipal issuer that sets out the terms of the offering. MSRB Rule G-32 bars a dealer from selling a new-issue municipal security to a customer unless the customer receives a copy of the official statement by no later than settlement of the transaction. For municipal securities other than municipal fund securities, the dealer may instead rely on the official statement posted to EMMA, but only if it sends the customer, by settlement, a notice saying how to get the official statement from EMMA and that a paper copy will be provided on request. Posting the document alone, with nothing sent to the customer, does not meet the rule.

Exam terms

Registration statement

The filing an issuer makes with the SEC before a public offering.

Prospectus

The disclosure document delivered to buyers in a registered offering.

Red herring

A preliminary prospectus used before effectiveness; its legend says the information is incomplete and no sale can be made yet.

Indication of interest

A non-binding signal that a buyer may want shares; no money or binding order before effectiveness.

Cooling-off period

The wait between filing and effectiveness, 20 days by statute unless the SEC sets an earlier date. Offers and indications of interest are allowed; sales are not.

Private placement

An unregistered sale relying on an exemption such as Regulation D.

Accredited investor

A buyer who meets income, net worth or professional tests under Regulation D.

Restricted securities

Unregistered securities whose resale is limited by Rule 144.

Shelf registration

A registration under Rule 415 for securities offered on a continuous or delayed basis, sold in tranches over time.

Blue-sky law

A state’s own securities law, administered by the state securities regulator.

Covered security

A security whose state registration is preempted by Securities Act section 18, such as an exchange-listed security or a Rule 506 offering.

Official statement

The issuer’s disclosure document for a municipal new issue; it must reach the customer, or an EMMA access notice must, by settlement.

Notice filing

A filing a state may still require for a covered security, with a fee; it is not state registration.

Worked example

One company raises money twice in the same year, first from a small group of institutions and later from the public, and the two sets of buyers end up with different rights.

1. The first raise goes to a handful of institutional buyers under Regulation D. There is no registration statement and no prospectus; the buyers receive a private placement memorandum.
2. Those buyers hold restricted securities. They cannot sell into the market the following week; Rule 144 conditions have to be met first, and until then the position is illiquid.
3. The second raise is registered. A registration statement is filed, the cooling-off period runs, the registration becomes effective, and every buyer receives a prospectus.
4. Those shares were registered, so they are not restricted securities. A buyer who is not an affiliate of the company can generally resell them in the market without waiting on Rule 144.
5. The antifraud rules covered both raises equally. If the placement memorandum had misstated the company’s finances, the exemption from registration would have been no defense at all.

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