A New Statutory Exemption for Private Resales of Restricted Securities Enacted

A New Statutory Exemption for Private Resales of Restricted Securities Enacted
Frenkel Sukhman LLP
February 6, 2016

On December 4, 2015, President Obama signed into law The Fixing America’s Surface Transportation Act (the “FAST Act”), which establishes a new statutory exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”), for private resales of restricted securities buried among other securities and non-securities law provisions. New Section 4(a)(7) of the Securities Act exemption codifies a private resale exemption similar (but not identical) to the informal “Section 4(a)(1-1/2)” private resale exemption which was developed over time by the securities bar through court rulings and SEC no-action letters.

The new Section 4(a)(7) provides an exemption from registration for certain private resale transactions meeting the following requirements:

• Each purchaser is an “accredited investor” as defined in Rule 501 under the Securities Act;
• No “general solicitation” or “general advertising” is used in connection with the offer or sale;
• The seller is not the issuer or a subsidiary of the issuer;
• The securities are not part of an unsold allotment to, or a subscription or participation by, an underwriter of the security or a redistribution;
• The securities have been authorized and outstanding for at least 90 days prior to the date of the resale; and
• Certain information has been provided by the seller to the purchaser.

Mandatory information disclosure is one key element in which the Rule 4(a)(7) exemption differs from the informal 4-1/2 exemption and the one which would likely be most difficult to implement in transactions involving startup or small companies due to the requirement of preparing GAAP financials.  All issuers who are not reporting companies under the Securities Exchange Act of 1933 (the “Securities Exchange Act”) would also need to consider using confidentiality agreements to protect their proprietary information and address issues raised by material non-public information if they agree to cooperate with the transferor of restricted securities and permit disclosure of such information to the transferee.  In the case of a transaction involving the securities of a non-reporting issuer, among certain other categories, the seller and the prospective purchaser are entitled to receive from the issuer, at the request of the seller, current information about the issuer, including, but not limited to:

• the issuer’s name;
• the issuer’s address;
• the title and class of the security to be sold;
• the par value of the security;
• the total number of shares outstanding as of the end of the issuer’s most recent fiscal year;
• the name and address of the transfer agent or other person responsible for the transfer of such security;
• the nature of the issuer’s business;
• the names of the issuer’s officers and directors;
• the names of any person that will receive commission or other remuneration in connection with the sale;
• the issuer’s most recent balance sheet and profit and loss statement and similar financial statement for the two preceding fiscal years during which the issuer has been in business, prepared in accordance with GAAP; and
• if the seller is an affiliate, a statement regarding the nature of the affiliation accompanied by a certification from the seller that it has no reasonable grounds to believe that the issuer is in violation of the securities laws or regulations.

The new Section 4(a)(7) exemption is not available if the seller, or any person who will receive a commission or other remuneration in connection with offering or selling the securities, is subject to the “bad actor” disqualification under Rule 506(d) under the Securities Act or statutory disqualification under Section 3(a)(39) of the Securities Exchange Act. In addition, the new exemption is available only for securities of an issuer “engaged in business” and not in an organizational stage or in bankruptcy or receivership, and not a “blank check”, “blind pool” or “shell company” or special purpose acquisition company.

Any securities acquired in accordance with the Section 4(a)(7) exemption will be deemed to have been acquired in a transaction not involving a public offering and will be deemed to be “restricted securities” within the meaning of Rule 144 under the Securities Act and “covered securities” for state securities law (“blue sky”) purposes. The resale transaction will not be deemed to be a “distribution” for purposes of Section 2(a)(11) of the Securities Act.

The new Section 4(a)(7) exemption is presumably not exclusive of other available resale exemptions (i.e. pursuant to Rule 144, Rule 144A or Rule 904). The statutory safe harbor the new rule offers presents certain advantages over the conditions of those exemptions but has its own burdensome limitations not imposed by the other rules. Its enactment promises to give holders of restricted securities a wider choice in structuring exit transactions and possibly bring about greater liquidity to secondary markets. However, every resale situation must be analyzed on the basis of its own facts and circumstances to determine which exemption would fit the parties to the transaction best, including in light of the contractual requirements for transfer imposed by the currently existing private placement documentation. Finally, it is not entirely clear whether a seller may still rely on the common law exemption known as Section 4(a)(1-1/2) in the event it does not comply with Section 4(a)(7) or other statutory exemptions. There is no legislative history on point and the SEC has not addressed this issue yet.

Issuers should consider updating their organizational documents in connection with the provisions governing securities compliance requirements for permitted transfers in order to accommodate resales of restricted securities pursuant to the new exemption.  Although issuers are not parties to secondary securities transactions, they have normally imposed certain contractual requirements (including legal opinion from a securities counsel to the transferor with respect to the availability of an exemption from registration for the proposed transaction) as conditions to recognizing the transfer.  With the possibility for a greater involvement of issuers in the resale process due to the informational requirements of the new statutory exemption, it is in the issuers’ interest to define clearly the rights and obligations of all parties concerned.

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Frenkel Sukhman LLP advises its fund and other clients in the financial services and other industries on securities law compliance issues and represents issuers and holders of restricted securities in private placement issuance and resale transactions on the regular basis.

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