Section 4(a)(2) Issuer Private Placements

Section 4(a)(2) of the Securities Act exempts from registration offers and sales by the issuer that do not involve a public offering or distribution. It is a transactional exemption and only exempts the particular offer and sale of unregistered securities by the issuer. It does not exempt the securities from registration indefinitely. Resales of the issuer’s securities by investors must be registered or have an available registration exemption.

An issuer is any person who issues, or proposes to issue, a security. An issuer’s affiliates or control persons cannot use Section 4(a)(2).

What is a Public Offering?

While the term public offering has never been defined formally by the SEC, several factors have emerged from case law and SEC rulings that set out when transactions are not deemed to involve a public offering for purposes of Section 4(a)(2):

•              Investor suitability. As one of the key factors to using Section 4(a)(2), investor suitability looks to whether an investor can “fend for itself” or needs the type of information disclosed under Section 5’s registration requirement to make an informed investment decision. Offerees must be sophisticated and have knowledge and experience of financial and business matters to evaluate the risks and merits of the proposed offering. Although not defined by Section 4(a)(2), sophisticated investors would include:

•              qualified institutional buyers (QIBs). An important category of QIBs includes any bank, savings, and loan association, or other institution that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers not affiliated with the QIB and that has an audited net worth of at least $25 million. There is also a “catch-all” category allowing any type of entity to qualify as a QIB, so long as it meets the $100 million threshold for securities owned and invested; and

•              accredited investors, including institutional accredited investors, registered broker-dealers and investment advisers, and key employees of the issuer, among others. Also included are natural persons who hold certain professional certifications, or who are “knowledgeable employees” of private funds and are investing in the private fund.

•              Limited number of investors. Typically, issuers limit the number of potential investors and buyers, but a formal numerical test has never been upheld. Generally, the number of potential investors and buyers is limited to decrease the chances of an offer being made to an unsuitable investor. However, issuers can and do conduct private placements under Section 4(a)(2) to an unlimited number of institutional investors that are QIBs if the issuers do not conduct any general solicitation or advertising of the offering.

•              Prohibition on general solicitation and general advertising. Another key factor to using Section 4(a)(2) is that there can be no general solicitation or general advertising of the offering by the issuer or anyone acting on its behalf. An offering or distribution that violates this prohibition is considered to be a public offering or distribution of the securities.

•              The Jumpstart Our Business Startups Act of 2012 (JOBS Act) did not, by its terms, change or remove the ban on general solicitation and general advertising for private placements under Section 4(a)(2), although it did require the SEC to eliminate the prohibition on general solicitation and general advertising for Rule 506(c) offerings under Regulation D.

•              Information requirement. Although Section 4(a)(2) does not require any specific information to be furnished to investors, typically potential investors receive a private placement memorandum, which is a disclosure document prepared by the issuer that provides investors with basic information about the issuer and the securities being offered. This document typically includes some of the information found in an SEC registration statement for public offerings, including the most recent two years of balance sheets; profit and loss, retained earnings, and similar financial statements; as well as a description of their business operations and the securities being offered for sale.

•              Transfer restrictions on restricted securities. Buyers are generally required to buy larger blocks of unregistered securities that carry transfer restrictions to increase the likelihood these restricted securities are bought by suitably sophisticated investors.

•              Investment intent. Investors must buy the unregistered securities for their own account, without a view to resell or distribute them to others immediately. Investment intent is relevant to show that the sale does not involve a public offering or a distribution of securities. This “view to distribute” prohibition does not mean investors cannot buy if they intend to resell the restricted securities under another available exemption, such as Rule 144A.

•              Integration with other offerings. Issuers cannot make a series of private placements to avoid Section 5’s registration requirements.

These factors, while helpful, do not provide clear direction on how to conduct an issuer private placement. In response, the SEC adopted Regulation D in 1982 to give issuers certainty about conducting a Section 4(a)(2) private placement.