Private placingsSpecific regulation
Are there specific rules for the private placing of securities? What procedures must be implemented to effect a valid private placing?
Yes, section 4(a)(2) (formerly 4(2)) of the Securities Act exempts ‘transactions by an issuer not involving any public offering’. A substantial body of case law and SEC regulatory practice has developed concerning private placements under section 4(a)(2). The availability of the exemption turns on a factual analysis of several factors, including the number and sophistication of the offerees, the relationship between the issuer and the offerees, the minimum denomination of the securities being offered and the relative bargaining power between the issuer and the offerees. To ensure compliance with section 4(a)(2), issuers often have purchasers make certain representations as to their sophistication as investors and their receipt of all requisite information in connection with the offering.
To provide issuers with certainty regarding the section 4(a)(2) exemption, the SEC adopted Regulation D, which provides three regulatory exemptions from the registration requirements of the Securities Act. Rule 504 and rule 505 of Regulation D provide exemptions from the registration requirements of the Securities Act for certain securities offerings limited in aggregate dollar amount (eg, offerings not exceeding US$1 million or US$5 million, depending on the parameters of the offering). Rule 506 of Regulation D (by far the most widely used Regulation D exemption) provides issuers with a non-exclusive, ‘unlimited’ safe harbour under section 4(a)(2) of the Securities Act, that exempts offerings of an unlimited amount of securities to an unlimited number of ‘accredited investors’ (eg, institutions and certain wealthy individuals) and to no more than 35 non-accredited investors. The previous prohibition on general solicitation and advertising in rule 506 offerings was eliminated by rules adopted by the SEC pursuant to the JOBS Act. The relevant rule changes became effective in September 2013 and allow general advertising and solicitation in rule 506 offerings as long as all purchasers are accredited investors. In an offering made under Regulation D (subject to narrow exceptions), the issuer must exercise reasonable care to ensure that the purchasers are not taking the securities with a view to distribution or other resale.
The primary method of offering high-yield debt securities in the United States is through a section 4(a)(2) private placement by the issuer to financial intermediaries, immediately followed by a resale of such securities to ‘qualified institutional buyers’ (QIBs) pursuant to rule 144A of the Securities Act, in ‘offshore transactions’ pursuant to Regulation S, or using both methods. Resales pursuant to rule 144A and Regulation S are more fully described in questions 9 and 10.
As required by the JOBS Act, the SEC adopted amendments that took effect in June 2015, which created a new exemption from registration pursuant to section 3(b) of the Securities Act for up to US$50 million of securities (referred to as ‘Regulation A+’). Under another requirement of the JOBS Act, the SEC adopted rules that took effect in May 2016, which created a substantial regulatory framework providing for a crowdfunding exemption from registration, whereby small aggregate amounts of securities of an issuer can be sold through brokers or internet ‘funding portals’ to investors in small individual accounts.Investor information
What information must be made available to potential investors in connection with a private placing of securities?
If a sale is made to a non-accredited investor, Regulation D requires that certain information be provided to the purchaser within a reasonable time before the sale. The information to be provided varies according to whether or not the issuer is a reporting company under the Exchange Act, but in either case such information is similar to that which would be required in a registration statement in the case of a registered offering under the Securities Act. Regulation D does not require that any specific information be provided to accredited investors. Nonetheless, in practice issuers generally provide potential purchasers with information similar to that provided to non-accredited investors.
In addition, rule 144A and Regulation S have limited information requirements. However, issuers offering securities via section 4(a)(2) private placements coupled with resales pursuant to rule 144A and Regulation S typically provide information that is similar to what would be required in a registration statement in the case of a registered offering under the Securities Act.Transfer of placed securities
Do restrictions apply to the transferability of securities acquired in a private placing? And are any mechanisms used to enhance the liquidity of securities sold in a private placing?
Yes. Unregistered securities purchased in a private placement may not be resold except pursuant to a registration statement under the Securities Act or an exemption contained in the Securities Act or the rules and regulations thereunder. Several mechanisms exist to facilitate the resale of these ‘restricted’ securities.
One such mechanism is the ‘section 4(1-½)’ exemption, now ‘4(a)(1-½)’, which allows investors who purchased restricted securities in a valid private placement to resell those securities in a further private placement following the procedures set forth in section 4(a)(2) without being deemed an underwriter engaged in a distribution of securities (who would not be exempt from the registration requirements of section 5 of the Securities Act). In December 2015, new section 4(a)(7) to the Securities Act was adopted; this exemption essentially codifies the ‘4(a)(1-½)’exemption.
A similar, but more commonly used, mechanism for resales of restricted securities is rule 144 under the Securities Act. Rule 144 defines the circumstances under which an owner of restricted securities or an affiliate of the issuer may offer and sell such securities to the public without being deemed an underwriter engaged in a distribution of securities. Rule 144 provides a non-exclusive safe harbour for the resale of restricted securities of a reporting issuer beginning six months after issuance of such securities, subject to requirements as to the public availability of certain information regarding the issuer and, in the case of resales by affiliates only, to limitations as to the manner and volume of such sales. With respect to the restricted securities of a non-reporting issuer, rule 144 provides a non-exclusive safe harbour for resales beginning one year after issuance of such securities. Under rule 144, after a one-year holding period, public resales of restricted securities of reporting and non-reporting issuers may be made by non-affiliates without any restriction.
Another important mechanism for reselling restricted securities is pursuant to rule 144A under the Securities Act. Rule 144A permits an investment bank or other financial intermediary which has purchased restricted securities from an issuer in a private placement to make resales of those securities to an unlimited number of QIBs without being deemed an underwriter engaged in a distribution of securities. Generally speaking, QIBs consist of large institutions that own or invest on a discretionary basis, in aggregate, at least US$100 million in securities of unaffiliated issuers. Sales under rule 144A can take place immediately after a valid private placement under section 4(a)(2), and securities acquired by QIBs pursuant to rule 144A are deemed to be ‘restricted securities’ for purposes of the resale restrictions. Rule 144A may not be used to offer securities that are fungible with (ie, of the same class as) a listed security, and therefore it is not available in connection with equity offerings (other than convertible offerings with a conversion premium of at least 10 per cent) of companies whose shares are listed on a US stock exchange.
Finally, Regulation S under the Securities Act (as described in question 10) enhances liquidity for holders of restricted securities by allowing them to resell restricted securities in offshore transactions.